The end of the VC market...

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For the past few weeks, I’ve been chatting with more and more General Managers at VC funds who seem completely lost… Their portfolios are full of unrealized returns, startups with no clear cash-out path, struggling to raise new vehicles, and young Partners jumping ship. So I decided to dig a little deeper and figure out what’s really going on.

What’s the VC game?

VCs, or venture capitalists, bet big early on companies aiming to hit a billion-dollar valuation within the next 10 years. It’s a way to grab a substantial piece of the next unicorn, at a bargain price.

To hit those sky-high valuations, investors have always pushed entrepreneurs to burn cash like there’s no tomorrow to drive growth. But this has been done at the expense of proper business and financial structuring - and now they’re hitting a wall.

The Exit Crisis

To get a grip on this crisis and the wall that fund managers are running into, you need to understand the legal structure of these funds. Every 3 to 4 years, they raise an investment vehicle (a fund) that has a 10-year lifespan - about 7 to 8 years for investing and 2 to 3 years for exiting. The performance of a fund isn’t solidified until the exit phase, until then, it’s just paper gains.

There are six main ways to exit:

1. IPO – The dream scenario, hyped by the VC mythos but rarely the reality. In 2023, we saw about 154 startup IPOs in the US and a whopping 732 in Asia-Pacific, but here’s the kicker - only 35% of them actually saw their valuations go up in the first three months! In short, IPOs are still mostly a pipe dream, despite efforts from players like FranceDigital trying to turn them into reality.

2. Acquisition by a big player – Another dream exit, but no easier than an IPO. While acquisitions are statistically more common, they’ve become rarer in recent years thanks to tighter regulations from bodies like the FTC and similar agencies worldwide, all cracking down on tech giants.

3. Selling shares – A lesser-known strategy. Top VC funds know how to exit at the right moment by selling shares to another fund. This route may not deliver the huge returns an IPO could, but hey, better 1 than 0, right?

4. Selling the fund – Similar to selling shares, but here, some funds sell all or part of their portfolio to secondary fund managers. It’s like a VC secondary market where a primary fund sells its portfolio to a secondary player, who picks up the pieces and tries to make a return.

5. LBO and PE (Leveraged Buyout and Private Equity) – These strategies are practically never mentioned in the tech world, and for good reason - they focus on profitability, which is something tech companies struggle with. These strategies involve starting with a profitable company and helping it scale to ensure returns. But in tech, this is where the problems start.

So, what’s the issue?

The problem is structural, baked into the heart of the VC model: profitability. Entrepreneurs have been fed on a steady diet of burning cash without learning how to financially structure a company. It’s rare to find founders who understand financial structuring well.

This creates startups that aren’t profitable, can’t raise more money because they’re overvalued, and can’t exit because they’re too big for acquisition and there’s no market for an IPO.

The Fund Managers’ Strategy

To get around this mess, fund managers have found a solution: hit the reset button. Several firms have paused their roadshows and are now laser-focused on their portfolios. The strategy? Replace the CEO (founder) with someone who can turn the startup profitable, which will allow the fund to exit or at least properly value its portfolio.

This approach lets fund managers show portfolio performance either through selling to another fund (whether a secondary fund or PE) or via an internal LBO at the startup. This, in turn, helps the fund raise a new vehicle.

The World After

If there’s one thing everyone in the VC world agrees on, it’s that restructuring is a must. The game’s no longer about chasing returns - it’s about tax benefits, syndications, and crowdfunding platforms exploding, while traditional funds are struggling.

We’re all partly responsible for this situation, and I’m no exception, having organized VC training sessions at GVentures.

So, how do we change the tune?

For me, the future of VC is structurally different. The 10-year funds, the endless roadshows, and the lack of structuring - that’s all got to go. So does the innocence!

I’m increasingly convinced that the future lies in evergreen funds, where investors can come and go periodically, based on a predefined liquidity formula. This model will ease the pressure of time, leading to better capital allocation while also financing different kinds of projects - deep tech, industrial, technological, … - all while keeping performance in sight.

But this model also requires a paradigm shift. Term sheets need to include a profitability goal within 6 to 7 years after the startup’s creation - a reasonable timeframe even for the most complex deep tech projects. This obligation will push entrepreneurs to think in terms of 10 years and focus on profitability, ensuring their future, both professionally and financially.

This evolution, I believe, is the only way to safeguard the venture capital market as we know it. The market is becoming more and more childlike, taking us back to a pre-industrial era where people fund projects one by one, without really knowing what they're doing, all in the name of chasing tax benefits. This can only lead to massive capital losses, bankruptcies, and a decline in growth.

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