Why Institutional Investors Are Turning Down Venture Funds

Here are the most common reasons why pension funds and funds of funds are handing out rejection slips to venture capital funds.


Venture capital isn’t going out of business, but many venture capital funds may be. As they make their pilgrimages to institutional investors — public pension funds, funds of funds — they are suddenly faced with rejection slips.

For many venture funds that have been used to turning down entrepreneurs — sometimes brusquely and often without explanation — these rejections have been hard. Even harder: The explanations that venture funds are getting for the turndowns range from the real to the disingenuous. Here are the three most common reasons for rejection:

1. Overcommitment to alternative assets such as private equity and venture capital. No further commitments now.

In the 1980s most institutional investors allocated no more than 1 percent of their assets to venture capital. With the industry’s success, that number kept creeping upward although public pensions have capped their allocations to alternatives — real estate, hedge funds, private equity and venture capital — at about 10 percent of their total assets. And as the value of equities and bonds have dropped, the proportion devoted to alternatives has risen.

“Our marketable securities are still under water. So our alternative assets look — skimpy as they are — too large compared to the rest of the portfolio.”

2. Buying operating partnerships (secondaries) at deep discounts.

Don’t want to get involved with new illiquid venture capital partnerships.

Most venture capital funds draw down their capital in tranches. As they spend down the initial tranche, they then call the next. And even if a fund isn’t faring well, these capital calls have to be honored. Instead of paying up, many beleaguered institutional investors are selling off their partnership interests — at deep discounts — to others who will honor the capital calls.

3. Investing only in top-quartile funds. Smaller, lesser-known funds are low on our list of priorities.

In the best of times, getting into the top venture funds has been near impossible for many institutional investors. Investment in successful funds such as Kleiner Perkins Caufield & Byers, Sequoia and Matrix has been by invitation only. But as investors have pulled back on their commitments, even the top-quartile funds are looking for new investors. Institutional investors, once limited in their choice of funds, are now upgrading.

But if these are the three reasons most often mentioned reasons for turning down venture capital funds, there are plenty of unmentioned ones. Some institutional investors simply don’t have the capital to make new investments. “We haven’t been doing too hot ourselves. We’re out of money and trying to raise our own funds” is one common refrain.

Others feel that they should get out of domestic markets and look abroad — specifically, at the BRIC countries. And with big investment banks such as Goldman, Sachs & Co. regularly promoting new BRIC-based assets, the grass on the other side looks greener, according to many asset managers. How much worse can they be than existing domestic markets? many ask.

Of course, there are the managers who are upset that venture funds — many without any capital distributions — continue to extract hefty management fees and are coming back for more. One typical response: “You’ve got nearly $100 million of our money and we haven’t gotten our capital back. You want more?”

Asset managers probably have never been in the predicament they now face. Public pension plans, which posted a median annualized return of 9.3 percent over the past 25 years, have had returns of only 3.9 percent over the past ten, according to Callan Associates, a pension consulting firm. And with real returns so low, many pension plans simply don’t want to commit to asset classes that have performed abysmally and don’t promise to do any better in the near future.

Call this the cluelessness confession that many asset managers are secretly making: “Our benchmarks are unrealistic. Our consultants are bleeding us dry. We need to pull back and take a close look at what we and others are doing.”