As the end of 2022’s first quarter approaches, limited partners in venture capital funds are expecting some not-so-pretty results from their portfolios. In short, the surprising markups of Q4 2021 aren't going to last, LPs tell Axios.

Why it matters: What goes (too far) up, must come down — just look at grocery delivery company Instacart’s newly cut internal valuation, which the company hopes will help with recruiting new employees by creating more upside.

What they’re saying: “We’ve seen more of an uptick in Q4 than we thought we’d see, and I think Q1 is gonna be a kitchen sink," one limited partner told Axios.

• Translation: Startup valuations and portfolio performance will be all over the place.
• “Q1 could be an opportunity for funds to reset the levels … you’ll see companies written down now, that should have been a couple of quarters ago,” he adds, noting that while VCs have said they'll be more disciplined on valuations, he hasn't seen that yet.

The big picture: Along with a likely reset in some valuations, LPs are also expecting a venture fundraising market that’s tougher for VCs raising new funds, as many of their peers are now over-allocated amid shorter fundraising cycles. Three-year fund deployment has turned into 18 months, and often bigger funds.

• Four fund-of-fund managers who invest in venture funds spoke with Axios on the condition of anonymity so they could freely share their thoughts.

Ukraine: Not surprisingly, the war will impact European VCs more than stateside funds. Not only are some of Europe's funds invested in startups based in Russia and Ukraine, but there’s also a broader concern about the war’s impact on the rest of the continent.

• “I am worried about the wild card of what happens if Putin flips the [gameboard in a tantrum] — what happens if he starts losing and escalates?” asked one investor. It's the same question haunting markets and businesses broadly on the continent.

Inflation: “It impacts the cost of startups, but where does it show up exactly?” questioned one LP. Another surmised it’ll make it more expensive to hire top talent.

Climate tech: While one has been investing in a well-known climate-tech VC firm, the rest said they’re happy to get their sector exposure via generalist venture funds.

• “I’m a child of the cleantech market, and that was painful,” said one investor of the bust a decade ago.

Solo GPs: "We've had to follow the talent and the deal flow — who's getting the cap table space?" said one of the LPs, who's backed three solo VCs. Several noted that entrepreneurs are increasingly drawn to individual VCs rather than firm brands.

• LPs were also split on their views of investors doing it as a "side job," and whether that can yield strong results and the commitment a venture fund requires.

1 👍 thing: All gave Tiger Global credit for what it's accomplished in boldly shaking up the market and questioning conventions like taking board seats.

• They also applauded Sequoia Capital's new structure — mostly because only Sequoia could pull this off.

The bottom line: LPs are adjusting to fewer distributions as the IPO window has shrunk and the SPAC mania (which largely didn’t go too well as far as their returns) has cooled.

High-profile crypto funds such as Haun Ventures’ $1.5 billion haul announced earlier this week keep making headlines, but not all LPs are jumping head first into the sector just yet.

Between the lines: As with climate tech, most investors told Axios they’re glad that some of their portfolio VCs have investments in the sector — and are generating some hefty returns. But they’re still waiting to get a clearer signal from the noise when it comes to the sector's future and viability.

• “I think crypto is overhyped in the short term and under-hyped in the long run,” said one LP. “In the short term it’s just a land grab, supported by all these hype bros.”
• Another investor, who's backed multiple crypto-focused funds and has watched the sector for several years, has steered clear of the hedge funds and monster-sized vehicles that cropped up more recently.

Yes, but: LPs are all keenly aware that a lot of talented technologists have joined the crypto ship, making it a sector they can’t ignore.

• "This is gonna be the new software of the Internet, so yes, you want to become part of it," said one investor.
• "We haven't had a strategy per se, to our detriment," admitted another.

What we’re watching: How quickly the crypto VC industry figures out better ways to make digital asset investments and distributions manageable for their LPs — it's a headache many LPs are inclined to keep avoiding for now, but one that remains top of mind.

• Popular practices like "staking" (akin to parking digital tokens in an interest-bearing savings account) are becoming tricky when it comes to taxes, for example.

Screendoor Partners, which backs underrepresented first-time venture managers, disclosed last week that it's grown to $87 million and deployed $26 million to nine funds.

• Axios caught up via email with Satya Patel, a partner at VC firm Homebrew and a member of Screendoor's investment committee (the interview has been lightly edited for length and clarity):

Screendoor said last week it has grown its fund from $50 million to $87 million — tell me about the funding bump.

"The increase in the fund size was driven by demand from new LPs who reached out or were introduced to us following the announcement of the fund. We also saw the volume of new managers that were approaching us was far greater than we expected, signaling that we would be able to allocate a larger fund and still generate the outsized returns that we expect."

Now that Screendoor has made a first batch of investments, how would you characterize the experience?

"... We have met many more new managers than we anticipated (over 350 to date) and the most surprising thing has been how well-versed the majority of them have been in the difference between simply investing and being a fund manager. There's so much more information available about being a VC than in the past, and these emerging managers have soaked it up and applied it to their work."

Tell me about the decision to invest in Footwork, a first-time fund that raised $175 million, whose managers were successful in VC and tech already.

"...[W]e'll ultimately be judged by our returns. This is not concessionary capital. ... [Footwork founders] Mike [Smith] and Nikhil [Basu Trivedi] are extremely talented, networked, and well-respected. On top of that, they share our vision for what the VC and tech industries can and should look like.

"So the only thing unique about investing in Footwork is that it's a bit larger fund than the majority that we expect to support with Screendoor, as most new managers won't raise that much capital out of the gate."

Is there a reason you don't invest in emerging managers from underrepresented groups that may be onto their second (or third) fund?

"As new LPs, we wanted to crawl before we walked. So that meant raising less capital than we could have raised and having a focused investment strategy oriented around helping to put new managers into business ...

"But I wouldn't be surprised if we find ways to support later funds at some point because the need for more capital being allocated there is just as clear as with first funds."

Are you tracking demographic metrics to make sure you're backing a diverse group of fund managers?

"Yes, we track demographic metrics through every stage of our pipeline. In addition, we don't have a firm definition of what it means to be underrepresented ...

"The nine firms we have supported to date have 18 GPs, of whom half are women and two-thirds are people of color. Eight of the nine firms are led by GPs who are all underrepresented."

• Calling the startup valuation peak (Axios)
• Even Your Allergist Is Now Investing in Start-Ups (NYT)
• How 'solo VCs' are changing the venture game (Pitchbook)

Many investors are pointing to the piles of cash venture capital funds have recently raised as a sign that valuations and investments won't dial down very much.

• Question: VCs had a lot of dry powder too when the dot-com bubble burst — what happened?