Venture capital funds are doing well – maybe too well

Industry insiders and investors express hesitance as startup valuations ascend to dizzying highs

Venture capital funds are doing well – maybe too well

The booming stock market has provided fertile ground for startups to notch impressive wins and generate profits for the venture capital funds that back them. But as the exuberance in the private capital markets show signs of descending into irrational euphoria, the managers behind those funds are getting worried.

According to data from Pitchbook, the value of U.S.-based venture-backed companies that were acquired or made their public debut this year through the third quarter reached US$582.5 billion, the Wall Street Journal reported. That’s sharply up from US$289 billion in 2020 and the first time the US$500-billion bar has been cleared.

“Numerous startups once backed by venture capital have been trading at market capitalizations of double-digit billions of dollars on public markets,” the Journal said, citing examples such as Robinhood and GitLab.

Driven by liquidity and rising valuations of still-private startups, VC funds are seeing very strong returns. For the top quartile of global venture funds raised in 2018, the net investment rate of return since inception as of the third quarter this year reached 42%, according to Preqin, edging out private equity and stock market benchmarks. Lower-quartile funds are also in double-digit return territory with gains above 10%.

A general influx of capital into the venture space – from traditional firms raising larger funds, as well as hedge funds and other new entrants in the venture investment sector – has pumped up valuations

“It’s going too well. I’m not actually that smart,” Matt Harris, a partner at Bain Capital Ventures, told the news outlet. “It can’t continue like this.”

Among the portfolio companies he oversees, five have either gone public or are preparing to list; others have raised private capital at higher valuations.

Cameron Joyce, vice president of research insights at Preqin, said that macroeconomic trends – notably, stubbornly low yields in 10-year bonds – are encouraging risk-on investment strategies, including venture capital. That’s collided with the overall success of technology companies at growing their revenues and pulling in more customers, with trends such as digital payments and e-commerce taking firm hold.

But Mike Larsen, managing director at Cambridge Associates, downplayed the significance of the recent leaps in valuations in the VC space.

“Are there great companies executing well and scaling rapidly? Yes,” he said. “But there is also a lot of noise, and noise seldom corresponds with long-term performance. The spike in IRRs [investment rates of return] will dissipate and in a few years we’ll have a clearer picture.”