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Earlier this week, London-based Balderton Capital announced $1.3bn in fresh funds ($615m for early stage and $685m for growth) — the largest haul dedicated to investing purely in European startups, and the most Balderton has raised in one go. It’s not the only firm raking in huge amounts of cash; Index Ventures and Accel have also raised big funds in 2024.
It got me thinking again about a topic of debate that regularly does the rounds in VC circles: the strategy behind fund sizing, and whether the market dynamics of the last year or so are changing it.
“If you have larger numbers behind your business card, maybe that opens some doors a bit more easily, but we think that’s the wrong reason to raise a larger fund,” Suranga Chandratillake, general partner at Balderton, tells me. He adds that its new funds aren’t much larger than its prior set (Balderton raised a $600m fund in 2021).
Breaking down fund sizing
When sizing a fund VCs consider things like the stage they’re investing in, how many companies they’re looking to have in their portfolio (and how much ownership they want of them) and how much they want to reserve for follow-on funding (many VCs say they reserve 50% of the total fund). But going bigger — even if you’re able to — is not always better, VCs tell me.
Where size does matter is in the returns you can generate for your LPs — and it becomes mathematically harder to get a huge return the bigger your fund. For example, if you want to return a $100m fund, you need at least one company to give you a $100m outcome. If you own 10% of the company by the time it exits, you need that company to have an exit of at least $1bn. Of course, most VCs are hoping for more than just one big hit in their portfolio. But the larger the fund, the bigger (or more frequent) the outcomes need to be to get your money back.
Most of the investors I spoke with for this piece — who invest largely at seed and Series A — target at least 3x returns for their LPs (net of things like management fees, which are typically 2% of the fund). A fairly standard model for early-stage funds: invest in 30 companies per fund to have a good chance of picking one or two big winners. This is what Balderton does, for example, with its early-stage fund. Other VCs like Seedcamp take a different approach: it spreads its bets across around 100 companies per fund. For growth, fewer companies fail at the later stages and therefore firms like Balderton aim to invest in about 15.
Two main themes in the market are impacting fund sizes: the size of rounds have gotten larger, and the biggest firms are getting bigger.
Round sizes have gotten bigger
A couple of VCs I spoke with said that the increasing size of rounds had a direct impact on the fund size they decided to raise. Sia Houchangnia, partner at Seedcamp, says a big reason why the firm doubled the size of its most recent fund ($180m, announced last spring) is that initial rounds under $1m were beginning to look like a thing of the past. “I don’t want to say this would never happen anymore,” he says, but “the average round size in which we would invest now would be $1.5m to maybe up to $2.5m range”. Founders are more willing to part with their equity now, though, he adds, compared to 2021 (up to 20%, more in line with 2019, he says). Seedcamp, which likes to lead rounds, aims for 7% to 8% ownership.
Houchangnia says there’s also been round inflation in follow-on rounds — which necessitates more money in the war chest.
So the question is, does this mean fund sizes will continue to be pushed higher? It could, Houchangnia speculates: perhaps in the next two or three years, first cheque sizes in Europe could increase further to, perhaps, $3m, “and that could add some pressure on the fund size”.
David versus Goliath funds
There’s also now more of a contrast between those massive funds (think the likes of Andreessen Horowitz, Sequoia or Index Ventures) which have raised billions and smaller firms consistently raising sub-$200m funds.
US VC Kyle Harrison called it the “productisation” of VC funds in a recent blog post. Essentially, there are the capital agglomerators, as he puts it, that raise multi-billion-dollar funds and don’t care if they throw $100m into a Series B company and it goes to zero because that’s a measly 1-2% of their fund. For smaller funds, those outsized bets need to pay off, and they’re looking for bigger returns. In other words, Harrison writes, they’re playing different games.
“I think there’s always been a bit of bifurcation; maybe it’s a bit more visible today,” says Chandratillake. Like Harrison, he notes there are two approaches: one where you raise big funds and hope to “carefully double or triple those,” and another where you raise smaller funds and try to find game-changing entrepreneurs really early on, invest early, and, if you get it right, win big. Balderton aims for the latter, he says.
VCs I spoke with agree that a key competitive edge for smaller funds is being able to focus more on each company. If a massive fund invests $1m in a startup, “it’s hard, just even if you operate purely rationally as a manager, to give the same importance to the company you deployed a million in versus the one you deployed a… $10m, $15m cheque at Series A,” says Houchangnia. Houchangnia, like the others running smaller funds I spoke with, have their biases — but the point is still a fair one.
“The bigger you are, the more the fees become important versus the performance. It’s well documented: bigger funds have lesser returns,” adds Pawel Chudzinski, partner at Berlin-based Point Nine Capital.
It reminds me of something seed investor Andris Berzins of Change Ventures told me last year while he was raising a fund — the target size of which was lower than its previous fund: “There’s obviously something around GP ego, right? Some GPs are excited by the idea of managing more AUM, bigger funds, bigger teams, writing bigger cheques” — and bigger funds mean more management fees for GPs.
Those with larger funds, like Chandratillake, say that “if you do well at venture, the management fees should be a rounding error”.
What’s next for VC funds?
Chudzinski predicts successful VCs on average “will get bigger and bigger,” but that we’ll see fewer new funds.
Others like Houchangnia expect that this year and next year, we’ll see European fund managers “rinsing and repeating,” raising the same size fund as their previous vintage; while there is a “large slice” of managers who’ll struggle to raise another one at all. “We’ve seen it already over the past 18 months, but you will hear of firms that are going dormant [or] maybe downsizing their fund.”
He’s also hoping, as a software investor, that the valuation multiples of public software stocks improve in the coming years: “If not, I do think that there is a more serious challenge around the economics of early-stage venture.”
Chandratillake is watching what will happen to firms that expanded outside their purview during the go-go days of 2021: Some VCs grew and “moved from seed more into Series A. It’s a hard transition; seed investments are very different to Series A investments,” he says.
I’m curious to hear from you, readers: Have you felt pressure from your LPs to raise bigger funds? Or have you decided to downsize instead? What are the main topics of conversation with your LPs right now? I’d love to hear from you.
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Read the orginal article: https://sifted.eu/articles/venture-capital-fund-size-2024/
