Preparing for the Downturn: Strategies for Managing an Emerging Venture Capital Firm
Originally published by RAISE, June 28, 2022
By Ben Black, John-Austin Saviano, and Joanna Drake
Everyone right now is worried that we are entering a massive downturn, and in recent weeks, we’ve seen VCs deliver a litany of advice to their portfolio companies on how to adapt and survive. We thought that our emerging VCs would appreciate some advice as well, especially since many new managers may have never lived through a big downturn.
We have a lot of experience to share here, so we’ve split this download into multiple articles. In our first article, we tackled the challenge of managing portfolio companies through a downturn. In this article, we’ll look at strategies for managing the business side of a venture capital firm during a downturn.
We’ll also be talking about how to deal with downturns at the 2022 RAISE Global Summit on October 20th in San Francisco. Please click here to apply for an invitation.
So, what should emerging venture firms expect and prepare for?
Just as your portfolio companies will be navigating uncertain seas, so too will it be for fund managers and especially smaller emerging managers. The fundraising environment can freeze virtually overnight.
Here’s how you can prepare:
1. Get ready for distracted LPs.
Expect your LPs to hunker down and focus on managing their existing portfolios. Most of your LPs are managing multi-asset class portfolios, which means they may have their attention drawn to any number of other stresses or opportunities. If you have institutional LPs, they will also have increased demands on their time to report to their investment committees and other constituents. Understand that new manager relationships are not as high on an LPs priority list right now as managing their existing portfolios.
2. Treat your LPs like they are your partners.
Now is the time to show your LPs that you have what it takes to be great stewards of their capital. Be honest and realistic. Be proactive. Show your LPs that you are thinking one step ahead of the competition. A downturn is a chance to create an LP for life.
Remember that your LPs are likely seeing stress in other parts of their portfolio, and your on-the-ground insights will help them understand this more-volatile world better. Focus on aggregating and interpreting real financial and operating metrics from your portfolio (ie., revenues, expenses, capital reserves, customer weakness or strengths) — all things which can help them better understand what they own via their investment in your fund. It also demonstrates mastery by a GP of the circumstances in their portfolio.
Look for anecdotes that are particularly enlightening to you and pass them on. While they may not have the rigor of data, if it is something you found truly remarkable, chances are your LPs will appreciate the insight.
3. Manage your expenses.
It may be a long time before you can raise another fund. Keep your expenses low and stretch those fees out as much as possible. Look at your burn rate just as you are asking your portfolio companies to do.
4. Adjust your fundraising strategies.
It may be tough to fundraise for a while, and GPs will need to adapt fundraising strategies. Consider what smaller investment rounds mean for fund size targets. Be mindful of the many LPs overexposed to venture. For some, this may mean adjusting target fund sizes, living with a more concentrated portfolio, then going out for a larger fund with more institutional LPs in a few years.
Stretch your fund capital by looking within your LP base and elsewhere for those LPs who have greater appetites for co-invests. A greater reliance on co-investment capital allows you to push off fundraising to a more favorable time while still growing AUM and actively investing.
One of the few pockets of LP capital in the US that isn’t at this moment completely saturated with illiquid exposure are the mass-affluent who invest via RIAs. As institutional investors are overwhelmed by their existing relationships, these RIAs have become an important new LP in the marketplace. Approach your individual investors and ask if they might make introductions on your behalf to any financial management firms they work with.
5. Understand how to handle defaulting LPs.
Defaulting LPs suck, but it can happen. Your LPA has very well-designed mechanisms for dealing with defaulting LPs. LPs default for many reasons. Sometimes they just run out of liquidity. Those individuals who were thinking they’d sell their liquid portfolio to fund capital calls may now find themselves over-extended. Institutions are not immune either, as even professionally managed pools can run low on liquidity. But defaulting LPs can provide wonderful additional economics for the LPs that stick with you. Understand your options and do right by those who stick by you.
6. Look for opportunities.
And finally, think about how you might find new opportunities during the downturn, including:
- Talent being released into the market, creating opportunities for hiring as well as new companies
- Better access to great companies, and opportunities to deepen your influence
- Protective terms and seniority in capital structures
- Smaller round sizes and better value on new deals, with advantages for smaller funds.
Fund vintages deployed in times of market stress often go on to be strong outperformers, so keep the bar high but stay in the game.
Again, we’ll be talking about how to deal with downturns at the 2022 RAISE Global Summit on October 20th in San Francisco. Please click here to apply for an invitation.
We are also considering hosting an event open to anyone and everyone in December or January — whether you attend RAISE this year or not — that would go into great detail about how to manage portfolios in tough times. We would like to know if such an event would be of interest to you. Please email firstname.lastname@example.org if you are interested in such an event.
~~~~~~~~~~~~ Disclaimer The Tipping Point Series, including Featured at RAISE articles, (“Tipping Point”) is a collection of interviews with fund managers who (a) have previously raised a venture capital fund and (b) are providing advice and insights into the formation and management of venture capital funds (the “Presentations”). Tipping Point is not an offer to sell or a solicitation of an offer to buy any security issued by any venture capital fund, including without limitation, any venture capital fund managed by Tipping Point’s speakers, presenters, or producers. The Presentations do not (a) provide investment advice with respect to any security or (b) make any claim as to the past, current, or future performance of any security or venture capital fund, and Tipping Point expressly disclaims the use of the Presentations for such purposes. The Presentations are not intended to constitute legal, tax, accounting, or other advice or an investment recommendation. Prospective fund managers should consult their own advisors about such matters with regard to their venture capital funds. Raising a venture capital fund involves significant risk of loss of income and capital, including loss of the full amount raised and invested, which may occur as a result of identified or unidentified risks. Tipping Point is produced by Raise Conferences, LLC (“Raise”). Raise is a private invite-only venture capital conference, which provides a forum for venture capital funds to network with and present to potential venture capital investors. Although Raise produces Tipping Point, the Presentations are independent of Raise’s conference and do not provide any forum for the Tipping Point speakers, presenters, or producers to solicit the sale of any securities.