“You can’t eat IRR.” Howard Mark’s famed comment is hitting a cord with cash-starved LPs craving distributions. As investors struggle to convert their paper returns into cash, unsold assets are piling up in venture portfolios, creating a significant liquidity crunch for allocators. With a sluggish IPO and M&A landscape intensifying concerns of substantial TVPI leakage, many LPs are prioritizing DPI and demanding deeper insights into the health of their underlying positions.
In 2021, VC exit activity exploded, reaching a record-breaking $1.5 trillion, up 152.9% YoY, sending distribution rates to their highest levels since the dot-com bubble. Yet, despite this exit boom, some LPs didn’t realize outsized DPI. Why? GPs were reinvesting at a frenetic pace. Many recycled distributions into new deals and pandemic-era funds ramped up dealmaking activity. In 2021, capital calls as a percentage of dry powder soared to 56.6%, the fastest rate VC firms have called capital down since the internet bubble and a far cry from historical averages.
These frothy highs of 2021 met a hard stop as the Fed rolled out one of the most aggressive tightening cycles in history. Between March 2022 and July 2023, the overnight borrowing rate was raised 11 times, from 0.25-0.50% to 5.25-5.50%. Exit markets and valuations quickly buckled under the pressure of a starkly different macro backdrop, throttling IPO and M&A activity.
Over the past several years, the resulting dearth of liquidity has left LPs hungry for distributions. The 12-month yield for distributions a share of NAV has hovered in the single digits for eight consecutive quarters, recently hitting a low of 5%. Against a roughly 16% average, this sustained dip reveals the depth of the liquidity shortfall. For example, in 2022 and 2023, VCs called $185B but only distributed $75B.
As Samir Kaji says, illiquidity is a feature, not a bug, of venture investing. So, while LPs understandably have concerns about cash returns, examining the relationship between early DPI and ultimate fund performance is important. VC is a power-law asset class; a select few winners drive the bulk of returns, and a significant illiquidity trade-off is required for these assets to mature. Big exits take time, and the journey to meaningful distributions is long and non-linear. For LPs, early exits run the risk of missing massive home runs.
As LPs prioritize DPI, many industry veterans have told cautionary tales about using early returns to project ultimate performance. David Clark, CIO of VenCap, found that the correlation between year five DPI and final performance across 71 funds from 2005 to 2008 was a mere 0.22. Similarly, Beezer Clarkson of Sapphire Ventures discovered that many of the firm’s 3x funds had little to no DPI by year five.
Then there’s the opportunity cost of selling a winner too early. LPs often put the profits and principal from distributions back at risk. The fundamentals of a great compounder should be weighed against the return prospects of new opportunities. David Zhou, Head of Investor Relations for the Alchemist Accelerator, has highlighted the return considerations of selling too soon: On a 12-year horizon, an asset growing at 35% annually generates more than half its total return in the final 20% of its life. Exiting before this value is captured leaves a large chunk of potential gains on the table.
This said, VCs are, first and foremost, fiduciaries of capital. Finding great compounders is only half the job; generating realized returns is equally essential. Despite ZIRP darlings like Stripe and Databricks poised for massive returns, their forecasted IPO timelines combined with six-month lockups mean LPs could end up waiting 18 years since their initial investment to get their money back. Considering that most LPs commit to 10-to15-year fund lifespans, frustrations over the extended timelines for these distributions are perhaps warranted.
Fund managers must find an important equilibrium between holding onto winners while being mindful of liquidity. Union Square Ventures is perhaps the gold standard for this tightrope. The fund boasts some of the most impressive DPI results in venture capital, achieving a cumulative 9x DPI across all its funds to date, with its 2012 vintage fund returning a remarkable 23x DPI. Fred Wilson, USV’s founder, has discussed the critical role of “taking money off the table” in fund strategy.
By selling portions of a position to return the fund (or more) while retaining the rest, USV positions itself for success regardless of the asset’s trajectory. If it becomes a home run, they can still reap a significant multiple; if it goes to zero, they’ve already locked in notable gains. Other industry leaders, such as Benchmark and Menlo, have adopted a similar philosophy regarding DPI, strategically generating liquidity by taking chips off the table at opportune moments.
These dynamics demonstrate the complexity of managing DPI in VC. While big winners can return the entire fund (and then some), sitting on enormous paper profits that can’t generate liquidity ultimately stifles performance. Letting assets mature to maximize value is crucial, but so is generating realized returns.
For LPs, the million-dollar question is how much TVPI will convert to DPI once the logjam meaningfully breaks loose on exit markets. LPs can gauge conversion challenges in their portfolios by exploring several angles to illuminate potential areas of concern.
Understanding overall exposure to the bubble of 2021 is a helpful starting point. VCs overpaid for many companies during ZIRP, securing long runways with cash-rich raises. Many of these unicorns haven’t returned to the market and can only hold their values on paper. For example, roughly 40% of these active unicorns are trading below $1 billion on the secondary market.
Assessing whether the value of these holdings reflects current market conditions is necessary to know where TVPI might get trimmed. What companies are clinging to a valuation overhang they can’t sustain and which have really strong underlying fundamentals and can grow into the price of their prior rounds?
Additionally, VC fund multiples hinge on two key factors: ownership and exit value. You need at least one or the other to drive returns — but both drive the home runs. Analyzing these variables in unison across a portfolio can reveal where funds may face DPI hurdles. Reaching a 3X return — which most LPs underwrite to — is often tougher for larger funds. These funds require ‘mega’ exits and tend to have lower ownership in portfolio companies, requiring a higher success rate to meet this benchmark. Even if IPO markets reopen on friendlier terms, the steep drop in public company multiples means outsized exits like those seen in 2021 will be harder to achieve.
Smaller funds, by contrast, can secure better ownership at favorable prices, often requiring fewer big wins to hit their return targets. The size of companies that smaller funds invest in also gives them more exit optionality. Companies have more accessible paths to M&A, providing more options for some quick cash wins, compared to more considerable funds whose underlying companies can typically only look to IPOs for exits.
Sector exposure also matters: are you overexposed to industries hit harder by current market dynamics? Private equity, for instance, is experiencing this impact in the healthcare sector. Antitrust scrutiny is disrupting roll-up strategies and exits, leading to lower distributions compared to PE’s distribution rate more broadly. VCs could encounter similar challenges in sectors strained by today’s economic environment.
Fintech, for instance, saw a boom during ZIRP. A good swath of these companies’ underlying business models rely heavily on low-interest lending, making them more sensitive to a high-interest rate environment. For example, Tally, a VC-backed company that helped users manage credit card debt, recently announced its shutdown after failing to secure new funding — despite raising $172 million and a peak valuation of $855 million. This follows VeeV’s shutdown last year, which was similarly exposed to the lending environment.
Another aspect of DPI risk is understanding correlation across your venture portfolio: How much exposure do you have to the same companies across funds and funding rounds from your GPs? As companies stay private longer, LPs increasingly hold overlapping positions with companies across funds. Social Capital’s Chamath Palihapitiya argues that this dynamic makes less correlated portfolios less vulnerable to market swings and TVPI-to-DPI leakage, acting similarly to a ‘low beta’ equivalent in public markets. During the ZIRP peak, fierce bidding increased prices for “star” companies. He argues these once-darling “alpha” opportunities will likely materialize more like market beta due to these sky-high valuations.
Then there’s track record. How effectively have your VCs turned paper markups into cash returns across funds, investing cycles, and macro environments? ZIRP-era funds launched on the front end of the 2010s were primed to capitalize on the liquidity-rich years of 2020 and 2021. Yet, many have notable leakage between TVPI and DPI compared to their predecessors. The persistent gap from mature funds in this cohort underscores an uncomfortable truth: securing exits is no easy feat. This reality should push LPs to ask hard questions about their managers’ strategies, processes, and largely unrealized performance.
Of course, funds launched on the backend of this era still have time to mature and could ultimately land at historical DPI averages. Many breakout companies from these vintages are still primed for massive exits that could deliver outsized realized returns for LPs whose GPs secured early access to their cap tables. Holding companies longer isn’t necessarily problematic — until growth and valuations hit a standstill. If venture capital’s liquidity issues have been more about complex exit markets than asset quality, DPI may fare better than expected.
This said, much of the TVPI growth in the 2010s likely resulted from access to cheap capital. The historically large herd of unicorns minted in the past decade may struggle to defend their lofty valuations with solid fundamentals. Instacart’s sharp valuation cut at its IPO last year underscores the harsh reality that many ‘darlings’ of this era will fall short of expectations, especially posing risks for LPs heavily exposed to later rounds.
Ultimately, this changing landscape allows LPs to reflect on which metrics are reliable indicators of a company’s long-term success. As allocators examine their portfolios for potential TVPI-to-DPI leakage across these factors, gaining insight will require aggregating and splicing data across multiple layers to pinpoint where leaks might occur.
Higher rates have played a leading role in stifling distributions, hiking borrowing costs, creating uncertainty, and squeezing valuations — particularly for high-growth, unprofitable SaaS companies. Many LPs and GPs view the trajectory of interest rates over the next year(s) as a pivotal cog in igniting the DPI flywheel at scale. Unsurprisingly, the Fed’s 0.5% rate cut in September, along with signals of more cuts to reach a 3% target federal funds rate next year, has fueled optimism that 2025 could, in fact, become the year exit activity revives.
However, mixed signals and market uncertainty continue to abound. Falling short-term rates don’t guarantee a drop in long-term rates, which are more closely tied to tech valuations and the “terminal value” of cash flows. In fact, since the Fed cut rates in September, the 10-year bond yield and long-term rates have risen, signaling that markets believe inflation is still a concern, which could stall future cuts.
This said, the freeze will break eventually. As allocators await the thaw, they will likely keep their checkbooks close to their chests. Many aim for a self-financing model where distributions from mature funds cover capital calls for new ones. But with cash dwindling, recycling into fresh commitments is off the table, and fundraising pressures will likely remain sticky. As GPs aim to deliver the liquidity LPs need for future fundraises, secondaries will increasingly serve as a dynamic tool for providing cash while allowing trophy assets to keep compounding.
Ultimately, as LPs navigate ongoing uncertainty, they will continue to assess the health of their underlying portfolio companies. However, uncovering potential TVPI-to-DPI leaks will demand slicing data across multiple layers to pinpoint where valuation haircuts could hit.
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