When are VC funds most sensitive to downturns
Thinking of raising a fund but weary of a potential market crash on the horizon. I'm wondering how the timing of a market crash would affect me, so here is my question:
Since venture capital funds have a 10 year time horizon, most will live through a market downturn at some point. When is it 'least damaging' for that downturn to happen?
Some of my thoughts on my own question (but would love to hear others):
If the downturn happens:
Before the fund is raised: A downturn would make it harder to raise the fund at all.
Immediately after the fund is raised: The fund will have opportunities to make its future investments at cheaper valuations associated with a down market, on the flip-side, entrepreneurs and employees may not get enough equity to incentivize them properly. On the other hand, the market itself would probably be unconducive to startup growth, leading to lower jumps in valuations between successive rounds and consequently, more dilution between rounds for both the VCs and the entrepreneurs.
Shortly after the fund is raised: Some of the pains of #2, though less pronounced. Additionally, any investments made to date will still be in their infancy and possibly their most vulnerable, so existing investments could take a big hit.
Halfway through the fund's life: My current front-runner answer
Near the end of the fund's life: A downturn could dry up the market for exits delaying returns.
If anyone has any data or experience relating to how fund returns are affected by the timing of a bust that would be great.
There is less capital getting put to work so you see higher quality deals at lower prices, and also the companies tend to run more lean and be more efficient as they have less access to capital. I also think the quality of the idea and business plan tends to be better because the people are more committed versus the past few years when everyone's doing a startup because it's trendy for MBAs.
1 will likely to kill your ability to raise a fund, and #5 will hurt your exits. #4 is also bad. You will want to start realizing your early investments at midway through your fund. This may put you in a position where you have some middling companies that have no buyers, but you need to continue supporting them or let them die. This happened a lot with VCs in 2009. They had to more or less segment their portfolios into three groups - 1) keepers that they'd keep funding or could self-sustain, 2) let them run to see if they survive but not going to put much more in and 3) let them die on the vine or sell for anything we can get. Being in #4 makes it likely you'd have to go through a similar process where you may abandon some investments that in a different market might actually make you money.Since most investments are made in the first few years, a downturn 3 years from now could also result in all your portfolio companies (which you invested in at high prices), being hit when they are young and vulnerable. Would that still be better than scenarios 4 and 5?
Also, just wondering what your experience is with VC. Thanks!
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