Introduction
Investing in venture capital funds can be a great way to gain exposure to the startup ecosystem and potentially earn high returns. However, not all venture capital funds are created equal. While big venture capital funds may seem like a safe bet, they come with a number of drawbacks that make them less attractive than smaller funds. In this article, we will discuss the reasons why investing in small venture capital funds may be a better choice for limited partners.
Power law (again…sorry)
One of the main reasons big venture capital funds don’t perform as well as smaller funds is because of the power law of venture investing. The power law states that a small number of companies will generate the majority of the returns for a venture fund. This means that if a fund is too large, it will be difficult to find and invest in those high-performing companies. Big VC funds also have to worry about asset gathering. When a fund gets too big, the fund managers are more focused on raising money to meet their asset targets, rather than finding the best investments. This can lead to poor investment decisions and subpar returns.
Size isn’t everything
Another problem with big VC funds is that they have a harder time putting all of the money to work. When a fund is too large, it can take a long time to find and invest in the right companies. This can lead to missed opportunities and poor returns. Furthermore, big venture capital funds are often referred to as “blow up” funds. Because if just one of their investments goes bad, the entire fund could be wiped out. This is why big venture capital funds are often riskier than smaller funds.
Transparency
Venture capital funds are notoriously opaque when it comes to their operations and investments. But this opacity is exacerbated when you have a big VC fund. For example, a big VC fund might have dozens of portfolio companies. It can be very difficult for limited partners to track what’s going on with all of them. Furthermore, big VC funds often charge higher fees than smaller VC funds. And because they’re less transparent, it’s harder for limited partners to know how their money is being spent. Limited partners in big VC funds often feel like they’re in the dark about what’s going on with their investments.
Getting fat
Another issue with big VC funds is that the partners may start to care more about management fees than performance. When a fund is too large, the partners can make a lot of money from management fees. They make those even if the fund is not performing well. This can lead to a lack of motivation to find and invest in the best companies. Finally, big VC funds may lose their passion for the investments they make. When a fund is too large, the partners may start to view investments as just another transaction rather than something they’re truly passionate about. This can lead to a lack of focus and poor returns.
Less thematic more generic
As Charlie Munger says if you do the same thing as everyone else you should expect to revert to the mean and that’s what big funds tend to do. On the other hand, smaller VC funds tend to be more specialised and thematic. They focus on a specific industry or theme. This allows them to have a better understanding of the market and make more informed investment decisions. They also tend to have a stronger alignment of interests with their limited partners, which can lead to better returns. Studies have shown that VC funds below $250 million outperform larger ones over 75% of the time! This is why many limited partners are opting for smaller funds, which are more likely to deliver the returns they expect.
Conclusion
In conclusion, investing in small venture capital funds may be a better choice for investors than big venture capital funds. Smaller funds are less risky, more transparent, and more likely to deliver the returns that limited partners expect. They also tend to be more specialised and thematic, which allows them to make more informed investment decisions. While big venture capital funds may seem like a safe bet, they come with a number of drawbacks that make them less attractive in the long run. If you’re thinking about investing in a venture capital fund, it may be worth considering a smaller fund. And one with a specific focus and a strong alignment of interests with the limited partners. With smaller funds, you may not only have a better chance of getting a higher return on your investment, but also a better understanding of the investments made, and a more transparent process. At the end of the day, it’s important to do your due diligence and research different funds before making a decision. But, in general, it is a good idea to consider smaller venture capital funds as a potential investment opportunity.
