A reckoning is coming for emerging venture funds, and that, VCs say, is a good thing

Thousands of new venture capital funds have launched over the past few years, each hoping to carve out a long-term, lucrative place for themselves. PitchBook is tracking over 10,000 funds currently trying to raise money, and 45% of them are emerging fund managers, defined as a firm with less than three funds.

Those funds are duking it out for a mere 16% of the total capital that limited partner investors will spend on venture capital, according to PitchBook, down from about 23% for the decade that ended in 2019, before the pandemic-era VC frenzy years.

More funds fighting for fewer dollars means a challenging landscape. We took the pulse of emerging fund managers about what it's been like for them during these post-ZERP, venture-capital-winter years. For the most part, things seem to be shaking out quite nicely for emerging managers despite the economic headwinds.

They admit that fundraising is tough, both for themselves and their founders, which means that in order to survive they are having to get creative. Some firms have had to cut their fund targets so they could close and start putting the funds to work. They’ve also had to get in with the big, multistage firms or risk losing out on deals.

“It’s really challenging how quickly things change within a market based on underwriting the type of founders we're looking for and how the public markets look,” Marcos Fernandez, managing partner at Fiat Ventures, told TechCrunch. “If someone's out there as a solo GP or even a couple of GPs without really anything too unique outside of being former operators, entrepreneurs, it's really difficult to raise an emerging fund right now.”

A different kind of fundraising

When Joanna Drake, co-founder and managing partner at Magnify Ventures, went from being an entrepreneur to an investor, she had to learn that fundraising for a startup is wildly different than for a fund.

“I found building the emerging fund one of the hardest things to do,” Drake said in an interview. “There's so much complexity around getting a first- or second-time fund off the ground.”

As an entrepreneur, you have a short list of firms, you set your target date, take meetings and within a certain period of time know if you will be successful raising for your startup or not. As an emerging fund manager, “you can actually wander for years taking meetings without a lot of feedback,” she said.

Drake’s pedigree includes three successful venture-backed exits, and what she called “a very perfect resume” that included Berkeley and Stanford. Even so, the “long-winded and challenging process to raise capital” inspired Drake and Ben Black to create Raise Global, a community for emerging fund managers and the “forward-thinking LPs” as it calls them, who back them.

They launched Raise Global nearly a decade ago. Its goal was to help emerging managers meet LPs who wanted “to take a risk on the emerging manager category, but didn't necessarily have the resources or the energy or time” to do the diligence on their own, she said.

A decade later, the Raise community includes hundreds of fund managers with assets under $200 million, and remains selective in its membership. Last year the org fielded 700 applicants, Drake said.

One exciting trend she’s seen through Raise is that the newest set of emerging managers are more geographically dispersed and more diverse than the classic Silicon Valley vest wearer. In addition, more emerging managers cracked the ceiling and were able to raise larger funds, some in the $100 million range, which used to be rare.

“The good news is we've been gathering data from both the LPs and the emerging managers for a decade now to show that there is a really exciting new set of managers coming through with a really different profile — geographically and diversity-wise — and LPs are really excited and continue to give back,” Drake said.

Raise’s research among 660 emerging managers confirmed that 2023 was not the best year to raise new funds. Data showed that only 20% of emerging managers were raising $100 million, or more, funds. In 2022, that was 29%, and in 2021 it was 26%. About 27% of managers were targeting the $50 million to $99 million range, down from 29% in 2022 and 36% in 2021.

Most of the action is taking place between zero and $49 million, where roughly 50% of emerging managers are raising, Drake said.

“That's important because while there's a handful of emerging managers that are able to raise larger than $100 million funds, it's really a small percentage of the market,” Drake said. “So, they actually do not have the capital to take the companies to a later stage. They have to work with the larger firms and put together the syndicates. It's actually one of the most important roles that they play.”

And, even if emerging fund managers successfully deploy their first funds and have good early results to show (although most funds take 10 years to return), that’s not enough to be secure.

Theresa Hajer, head of U.S. venture capital research at Cambridge Associates, agrees that there’s been an influx of emerging manager funds over the past seven years.

Cambridge is to VC funds what Michelin is to restaurants, helping to identify the best performers. But because of the odd winter period we’re in, past success isn’t actually a strong indicator on its own to access emerging managers, she warns.

Newer managers who were investing during the 2019-2021 party days haven’t yet had the opportunity to build a track record in an environment that has had a valuation reset. So limited partners “need to sharpen their pencils and look very carefully because you can't always rely on that performance,” she said.

Cambridge is carefully assessing younger fund managers with this in mind before giving them a stamp of approval. “This is a tough, tough environment,” she says. “But that's the stance that we've taken for quite a long time, and other sophisticated limited partners in the market have done so as well.”

Secret to success

Hajer also says it’s important for emerging managers to play to their strengths. That can be from a deal flow perspective, connections with founders or developing relationships upstream with investors at larger firms.

Many new managers are doing this by specializing. They are targeting certain industries where general partners feel they have the expertise to give. Among Raise’s applicants in 2023, 70% had a thematic focus, Drake said. It’s also what she's done for her own fund, Magnify.

“We've had some of the bigger firms, even at the Series A, reach back out and say, ‘We would like you to come in because you are the first investor in the care economy and in family tech. We need that domain expertise and want you on the table. We want the founders to have your support,’” Drake said.

However, that’s not the case for emerging fund managers in emerging markets like Latin America. Monica Saggioro, co-founder and managing partner at MAYA Capital, told TechCrunch that because LatAm has not yet been swarmed with pre-seed and seed-stage funds, those that are tend to be generalists.

“As the market matures and competition increases, I believe there will be a stronger push for funds to specialize,” Saggioro said, but at this rate of investment in the region, she thinks that trend could be 10 or even 20 years out.

For Nick Moran, general partner at New Stack Ventures, the best thing about being an emerging manager is the ability to be nimble. He compared it to being a startup competing with an enterprise selling to a big customer. Huge enterprises are often slow and laden with legacy baggage infrastructure. On the other hand, the startup is more innovative and can make decisions faster, Moran said.

And while the venture capital world has the Accels and Sequoias of the world, and while they “are wonderful and do great work, they were built in a different era,” Moran said.

Rather, emerging venture firms have to be as innovative as the startups that they invest in, which means you're no longer just dealing with capital, he said. They have to be unique, they have to have specialization, a unique thesis and insights that provide a value add for founders. Emerging managers also have to find the right partner at big firms that have a shared philosophy or sector, Moran said.

In addition, smaller VCs have the ability to spend more time with founders, helping them grow from zero to one. For example, assisting with finding and recruiting talent and introductions with potential customers. Smaller funds are also experimenting with AI tools to tap into better investment strategies.

“Emerging managers have to compete on a different dimension,” Moran said. “You don't want to be competing on the X and Y axis. You want to find a Z axis so unique that startups will jump to work with you and find room for you even when a Sequoia or an Accel or a Benchmark is involved.”

Other emerging funds are betting they can succeed by focusing as early as possible in a startup’s lifecycle. Magnify’s Drake said among the Raise firms she works with, 31% were working at the accelerator or pre-seed stages, while another 47% were working at the seed stage.

“That's where the real early company-building work needs to happen,” Drake said. “Most of them are former operators, like myself, where we've had all functional areas report to us, so we can actually carefully work with the founding team to help them with the early talent, recruiting and development strategies. That stage is actually perfect for emerging managers to really roll up their sleeves.”

Relationships with bigger firms

Emerging managers work at the top of the deal-flow funnel. They help larger venture capital firms find promising companies, backing them before they’d earn a nod from larger check writers, Moran said.

Nichole Wischoff, founder and general partner at Wischoff Ventures, told TechCrunch via email that “multistage funds are desperate for deal flow” and so they partner with any general partner they can to gain exposure to new deals. Those that successfully build such networks tend to thrive.

“This won't change,” Wischoff said. “Similar to startups, the few emerging funds who continue to be able to get into great deals and eventually show exits will become blue chip firms themselves. Many decide to go multistage because it's lucrative. Think Thrive Capital, Josh (Kushner) is really building something special here. The rest will fail.”

Having a good network of multistage firms is one of the ways Brad Zions, founder and general partner at Pitbull Ventures, helps his portfolio companies.

“It's about knowing the firms that like to invest in particular sectors and then knowing some of the partners who are the right people to champion a project or a potential investment in a startup,” Zions said in an interview. “I've developed a fairly extensive set of relationships with other emerging managers as well because I never lead rounds. I'm always able to squeeze into rounds that are just about to close.”

Both Zions and Drew Glover, general partner at Fiat Ventures, said emerging fund managers are also helpful for larger VCs as it relates to diligence. Fiat Ventures shares education and market exposure on top of working with companies at their earliest stages, Glover said.

As a result, the firm has a “very unique kind of macro and micro perspective on the entire world that a lot of VCs sit down and lean on us for,” he said. For instance, Fiat often has quarterly meetings with firms like Sequoia to discuss trends.

“Anyone who's not building relationships with some of the larger players is missing a huge opportunity,” Glover said. “These larger VCs are not going to take your call unless you have a really incredible track record with them that goes beyond just sending them a list of the top five businesses in your portfolio.”

A shake-out, then more success

Fiat Ventures’ Fernandez said that the VC winter has now lasted long enough that. “I do think that you're gonna see a shake-out,” he said.

All of these emerging funds are not going to make it. “That's an unfortunate thing because there are some incredible emerging managers out there,” he said. Perhaps some will be absorbed by other funds, or some of the best investors will be hired on by other firms, he predicts.

But when the thinning happens, those emerging funds with “staying power” will grow stronger, with “less competition for a smaller number of deals that are out there.”

New Stack Ventures’ Moran added that this will make the emerging managers with increased specialization even more valuable to larger firms looking to write Series A-, B- and C-stage checks.

Meanwhile, MAYA Capital’s Saggioro is seeing that in Latin America as well. If interest rates drop in 2024, combined with the quality of founders she’s seeing, it won’t take for “the flywheel of a thriving ecosystem to speed up in the following years.”