Thoughts on the current crypto VC landscape
It’s been a while since I wrote my last Substack article, so I wanted to share some takeaways from conversations I’ve had with LPs and other GPs in the past few months about the overall state of crypto VCs.
There’s a big disconnect between public perception of VCs and what’s actually happening behind the scenes, so hopefully this peels back the curtain a bit.
First, we need to define two important metrics.
DPI (distribution to paid-in capital). This is the hard cash distributed back to LPs, net of management and performance fees. This is by far the most important metric to LPs because it’s impossible to bullshit – it’s the truest measure of fund performance.
TVPI (total value to paid-in capital). This is how much all the fund’s assets are worth marked to market – aka the “paper gains.” There’s a lot of discretion for how VCs mark their assets (more on that below), so TVPIs tend to be very inflated. Good LPs can easily dig deeper in their due diligence and see through bullshit TVPIs.
Most funds that have high TVPIs have low DPIs.
This is what Chamath famously describes as the “VC ponzi” – show your paper gains to LPs to raise a massive mega fund and rake in juicy management fees.
Especially in crypto, there’s a lot of wiggle room for VCs to decide how to mark their books. For example, say a VC invested in a project that launched a token with a multi-year lockup and has thin liquidity on exchanges. Many will choose to mark their investment at the token’s current spot price without any discount, even though there’s no way they would be able to sell the tokens to realize such an amount. Hence why new shiny L1 VC chains continue to get funded.
Thus it’s prudent to realize good DPI over time to show your returns are actually real. Having a high TVPI is nice but you should let it fluctuate with the market and mark down investments when appropriate.
Most 2017-18 vintage funds have DPIs less than a16z crypto Fund I’s DPI.
Obviously I can’t share exact numbers, but a16z returning an X multiple for a fund of their size is very impressive.
a16z is a good brand and the equivalent of “nobody ever got fired for choosing IBM” for large institutional LP investment committees that have to come to consensus on decision making. For other lesser-known funds, why should an LP stick their neck out and choose them over a16z if their returns are potentially worse and the LP would have to take on more reputational risk? This is especially true for solo GPs raising Fund II right now and don’t have good track records for Fund I.
2021 one year vintage bull market funds are some of the worst performing funds.
One year vintage means the fund raised and deployed all the capital quickly in a single year before raising the next fund the following year. From asking around institutional LPs who’ve been allocating to venture capital for decades, I can’t find a historical example of a one year vintage VC fund that has performed well.
Any institutional LP will tell you the most important factor for fund returns is vintage year, not access to good dealflow nor ability to pick good companies. But as a VC, you can’t control the macro environment. Your job is to identify the best founders and themes in your expertise area, and deploy slowly across multiple years to diversify macro risk.
2021 was particularly a bad vintage year for crypto VCs. Seed deals were getting done at crazy $50M+ valuations pre-product in which the risk/reward made no sense. So many startups were fundraising that VCs felt pressure to deploy. On top of that, startups were raising subsequent rounds of funding in short periods of time, which forced earlier investors to exercise pro rata to maintain their ownership percentage before investors could see meaningful product traction. This caused VCs to deploy faster than expected and come back to LPs sooner than expected to raise their next fund.
Either be a small seed fund or a large index fund. In between is no man’s land.
This is a good example of dialectics (opposing truths at extremes). Seed funds are “snipers” – being first money in startups at attractive valuations, in which the risk/reward means only one of the seed investments has to hit to return the fund. Large funds are “aircraft carriers” – indexing the space and having meaningful ownership in most post product-market fit companies.
Fund size tends to be the signal of legitimacy that VCs compete on in public. Newer fund managers feel peer pressure to get to billions in AUM raised, but the fund size game tends to heavily favor incumbent brands. Seed funds that weren’t disciplined on fund size and raised much larger funds during the bull market are stuck in the middle right now – too big to have the upside investing in seed and too small to be a household name. They won’t be able to raise another fund of that size anytime soon and shrinking fund size reduces management fees.
Just because you can raise a much larger fund doesn’t mean you should.
VCs pulling term sheets and asking portfolio companies for refunds is unfortunately becoming more common in the bear market.
Pulling a term sheet means the VC agreed in writing to invest at particular terms, but while waiting on the legal docs to close the crypto market crashed and the VC then backed out of the deal. This doesn’t mean the VC has to actually sign the docs; see YC’s handshake deal protocol for what’s considered industry standard. Regardless, this sets back founders by several months because they have to waste time going out and fundraise again in a worse environment.
Asking a portfolio company for a refund means the VC funded the company in a bull market, but is feeling buyer’s remorse and wants the company to give their money back. It’s not as bad as pulling a term sheet because obviously there’s no obligation for the founder to say yes to returning money, but it’s still a stain on the VC’s reputation for being “founder friendly.”
So far I’ve heard stories, from founders and other investors, of five prominent crypto VC funds doing this. The most egregious offender has done this to at least five different companies. I’ve also noticed that generally the more effort the VC puts into their public brand perception, the more they feel they can get away with doing such bad behavior behind the scenes.