#9 VC Opportunity Fund Insights

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Today’s Top 3:

• Opportunity fund defined: a VC fund vehicle that targets “later stage breakout companies” from a traditional VC’s portfolio and deal flow. VCs typically start by raising a “core fund” (more on that here)

• Key differences: more concentrated, lower fees. These funds typically are more concentrated (i.e. ~10 investments) than a traditional VC “core fund” and have lower fee structures

• Deal flow, access, and returns are driving growth: Great VCs have access to unique deal flow / companies - this is a scarce and valuable resource! Investors can “buy” more of this access by investing in an Opportunity Fund 

Overview

One of the most valuable assets / scarce resources a VC has is unique deal flow. For years, VCs invested early in a company’s life, then stopped investing once the company achieved a certain level of “maturity.” Later stage investors then came in (after the company was substantially de-risked) and generated big returns on big dollars - painful for many of those VCs to see as they missed out!

Today, many VCs and their LP investors have realized that they can still invest in these more mature companies and generate great returns (many reasons for that, detail below). One way to do this is by raising an Opportunity Fund.

We define an opportunity fund as a VC fund vehicle that targets “later stage breakout companies” from a traditional VC’s portfolio and deal flow.

Over the past decade, we’ve evaluated and advised VC funds on >100 of opportunity fund vehicles, providing some unique insights. We’re excited to share some great research / writing done on this topic by others with our own spin on it!

Background

There’s a lot we could write on the background of opportunity funds and why they are becoming more prevalent today. Jeff Weinstein & Luke Skertich did a great job covering this earlier in 2021 in their post “VC Opportunity Fund Best Practices” so we’ll borrow their words:

“Early-stage venture capital has undergone a seismic transformation over the past decade as companies stay private longer, raise more capital and exit for larger magnitudes. According to SVB, the average VC-backed company at time of IPO in 2018 raised $184M across six rounds, up from $60M across four rounds in 2010. And the average length of time from founding to IPO doubled to 12 years. Meanwhile, valuations have increased accordingly, with 22 $1B+ valuation tech IPOs in 2020 to-date, up from 3 in 2010.”

“With startups staying private longer and growing larger, Seed and Series A venture investors have come across an interesting dilemma: with limited reserves to follow on across multiple financing rounds, what should they do with their pro ratas in their breakout portfolio companies?”

One answer: the opportunity fund! Used correctly, it can be a great tool for a VC fund to capture more of their portfolio’s value, generating greater returns for the LP investors, as well as supporting breakout companies.

But Wait. Can Opportunity Funds Deliver Great Returns?

One of the concerns LP investors have expressed over the years re VC Opportunity Funds was returns - can they still deliver the great VC returns expected by LPs?

While the data is still limited / early, the tidal wave of success that VC breakout companies are achieving in today’s market (from later stage multi-billion dollar fundraises to public markets listings) points us to the answer.

Fred Wilson at USV shared data on Opportunity Fund performance this past summer when discussing “Cash on Cash vs. IRR.”

While not apples-to-apples (different vintage years), the performance data (Q2’21) show the ability of opportunity funds to deliver exceptional returns, relative to core funds, as measured by cash on cash and IRR:

• USV Core (2008): 5x, 22.5%

• USV Opportunity (2010): 3.9x, 58.6%

• USV Opportunity (2014): 7.3x, 46.7%

Growth

Deal flow, access, and returns are driving growth: Great VCs have access to unique deal flow / companies - this is a scarce resource. Investors can “buy” more of this access by investing in an Opportunity Fund. Per Pitchbook, VCs have raised nearly ~400 opportunity funds over the past decade, and that number is growing.

In his recent post titled “Assessing the world of opportunity funds”, Samir Kaji noted that “in the past few years, opportunity funds have been raised by both seed firms such as Homebrew, Costanoa, Susa Ventures, and Uncork, as well as larger firms such as Lightspeed, 8VC, and Emergence Capital.”

Similarly, Different Funds provides some eye-opening stats in their post titled “The “Hidden” Capital of Venture Capital”:

“In 2019, non-flagship funds raised a total of $13.2 billion across 190 vehicles. Adding their weight to the $41B flagship market expands total venture capital raised in 2019 by a significant 32%, and means non-flagship funds account for about a quarter of total VC assets raised for the year.”

So What? Should You Raise an Opportunity Fund?

This is the (multi) million dollar question! The answer is nuanced - it depends.

We haven’t talked a lot about SPVs in this post but that’s often a driving factor that precipitates an Opportunity Fund (for more on SPVs, see SPV Need for Speed).

If you are a VC investor and are raising a lot of SPVs to take advantage of later stage deal flow, would it be easier / more efficient to raise a committed pool of capital? What do you and your largest investors think - what are the benefits and concerns from your and their perspectives?

Is it worth a conversation? We think so. In today’s market, things move fast and dynamics can change quickly, so there are a number of compelling reasons to consider this! Want to learn more? Please dive into the links we shared in this post!

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