Why Venture Capital Is Weighed Down by Its 2021 Vintage

The vintage’s poor showing is weighing down the returns of some venture funds’ limited partner investors, including university endowments. While the funds may yet improve their returns and many LP investors still believe in the long-term potential of venture capital, some LPs are losing patience.

The median net investment rate of return for 2021-vintage venture funds was 2.1%, compared with 12.3% for 2020 funds, according to analytics firm Preqin, which surveyed results from investment firms backing early-stage and late-stage private companies. The data is as of September 2023, the most recent available. 

“Faith and trust in funds have gone down,” said Sterling Snead, a principal at S&S Global Family Office. “A lot of people are more cautious with who they’ll work with.”

Snead said the family office has shifted from investing in venture funds to directly investing in startups alongside venture firms.

The California Public Employees’ Retirement System didn’t have much exposure to the venture asset class in 2021. Even so, funds of that year’s vintage that the pension system backed, and that invested in private technology companies, are some of the worst performers in its private equity portfolio. Calpers has backed more than 350 private-equity funds since 1998.

The 2021 vintage is overrepresented among the worst 20 performers in Calpers’ private-equity portfolio on a net IRR basis, as of Sept. 30, 2023.

For example, according to Calpers data, Springblue A LP managed by consumer venture firm Goodwater Capital had a net IRR of negative 13.3%. A Goodwater representative didn’t respond to a request for comment.

Additionally, the $4 billion TCV XI fund raised by Technology Crossover Ventures posted a negative 8.3% net return on investment, and Insight Partners XII, a $20 billion pool of capital whose deals ranged from Series A-stage startups to more mature private companies, stood at negative 7.5% net IRR, according to Calpers.

In March, Insight pegged its fund’s IRR at 0%, according to a person familiar with the matter. TCV declined to comment.

Private equity and venture funds typically have a 10-year duration and data captures performance at a moment in time.

A spokesman said Calpers’ 2021 venture investments were minimal and the returns of the asset class haven’t had a material impact on the pension system’s overall performance. Calpers said it doesn’t classify Insight and TCV funds as venture funds. The pension system recently decided to invest more into venture capital funds and back private tech companies directly.

Many other limited partners piled into venture funds at the peak of the market, during a boom in initial public offerings and quick valuation acceleration in private markets that drove stunning short-term venture returns. Globally, venture funds collected about $312.59 billion in 2021, a record amount, according to Preqin.

Flush funds quickly deployed capital into buzzy startups. On average, 2021 funds invested 30% of their capital in their first 12 months, roughly double the average deployment rate in venture capital, according to Theresa Hajer, head of U.S. Venture Capital Research at investment firm Cambridge Associates.

Then the market took a nosedive. Interest rates began rising in 2022, making asset classes other than venture more attractive. Company valuations dropped, public listings halted and startups began failing at a faster pace. 

As a result, venture funds had to mark down their holdings. Venture fund performance on a short-term basis turned negative by the end of 2022 and has continued slipping since then.

The underperformance is haunting the current venture fundraising market. Venture funds globally pulled in $117.7 billion last year, a bit over a third of how much they collected in 2021. Now, it is taking longer to raise a venture fund because investors are less likely to trust the values that funds assign to their holdings.

Bruce Lee, the chief executive and founder of Keebeck Wealth Management, said he isn’t invested in any 2021 vintage funds but is familiar with limited partners who are. Many are tired of fund managers stressing patience, he said, and are frustrated by their unwillingness to mark down portfolio companies.

“LPs are like, ‘Screw that, what’s the ARR and what’s the burn rate?’,” Lee said. ARR refers to annual recurring revenue, a measure used to help value a company. Burn rate refers to how quickly a company uses its cash reserves.  

Preqin expects average returns for 2023-2028 will be 5% lower than average returns for 2019-2022, reflecting the poor performance of the 2021 vintage. “We see a steep decline, a lot of that comes from this vintage,” said Angela Lai, an analyst at Preqin.

However, nearly all the value of 2021 funds is unrealized, according to Preqin data, meaning the money is invested in startups whose fortunes may yet improve. 

David York, a general partner at Top Tier Capital Partners, said he doesn’t plan to adjust venture allocation even if 2021 funds don’t pan out, noting LPs during the dot-com era had to stomach dismal returns for roughly five years.

York also believes the potential for new technologies such as artificial intelligence to shower investors with massive exits will keep LPs from pivoting away from venture. “We’re being patient,” he said. “You’d be a fool to skip out on AI.”

Write to Yuliya Chernova at yuliya.chernova@wsj.com and Marc Vartabedian at marc.vartabedian@wsj.com