Smaller venture funds continue to outperform the largest ones
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Venture funds smaller than $350 million are 50% more likely to generate a 2.5x return than funds larger than $750 million. That's according to new data from Santé Ventures looking at funds raised from 1979 to 2018.
Why it matters: This is a well-known dynamic, but it's important to continue examining new data.
- Especially since 46.8% of venture dollars went into U.S. funds $500 million and bigger in the first three quarters of 2023, and 63.6% did in 2022, per PitchBook.
The topline: The optimal venture fund size is $200 million to $350 million, according to Santé's new analysis.
- These funds are able to generate higher returns via typical exits.
- This is a change from the optimal fund size (from below $200 million to $250 million) in the firm's 2011 analysis.
Between the lines: Santé's latest study introduces the dimension of "market regimes": bear, balanced and bubble.
- Moreover, it concludes that "VC funds in the most recent balanced market regime of 2010-2020 have outperformed funds performed in other bear or bubble market regimes."
- This doesn't bode well for the funds raised at the height of pandemic froth … but you already knew that.
The big question: If that's the best-performing fund size, why does the big fund trend persist?
- From Santé: "[T]he net present value of management fees alone for a fund at $1,000M exceeds the fees and carry of a fund at $200M, even if it returned 4x." It's always about the fees, as the adage goes.
- For LPs, the firm argues it's a combination of lack of performance data since those huge funds are a new trend; the need to invest huge chunks of cash; and a misunderstanding of how venture returns work.
My thought bubble: I asked a longtime VC (whose firm sticks to a smaller fund). Her response was that "brands don't really die," suggesting that the inertia from LPs will keep those firms going fund after fund, even with lower returns.
The bottom line: Exit values remain the ultimate constraint on fund returns.
- While some phenomena, like mega-rounds or IPO booms, can affect those values, they remain the main driver of fund math.
- Santé's recommendation: "Our primary conclusion … is that a venture fund should be no larger than 1.0-1.5x the average equity value at exit of venture-backed companies in its investment sector."
