Are follow-on rounds really overpriced?

When is it prudent to shut down a vehicle for follow-on investments in your portfolio’s proven winners and opt to return unused capital to your limited partners?

That’s what CRV, based in San Francisco, has announced it is doing with the remaining $275 million in its second Select Fund, which closed on $500 million in 2022. Founded in 1970, CRV invests in the life sciences, consumer products/services and enterprise sectors.

In a recent Medium post (registration required), CRV says it has been closely monitoring the markets and its own portfolio over the last 18 months. “We raised Select Fund I ($200 million) in 2020 and Select Fund II ($500 million) in 2022,” it writes. “At the time, public market comps supported venture-like returns in later-stage rounds of our best companies. Between 2022 and 2023, we saw an adjustment taking shape, and it became more difficult to justify those returns.”

This isn’t the first time CRV has returned unused capital to LPs. It raised $1.2 billion for its flagship Fund XI back in 2000, but ultimately returned $750 million to investors two years later in the wake of the dot-com bust.

CRV partners declined to speak with Venture Capital Journal for this article, citing time constraints during a week of meetings with founders.

But a few other VC managers who have raised follow-on vehicles say they don’t share CRV’s concerns about inadequate returns on their investments.

Ryan Drant, founder and managing partner at Questa Capital, tells VCJ he isn’t finding it hard to get attractive valuations when investing in the later rounds of Questa’s strongest portfolio companies.

John Backus, co-founder and managing partner of Proof VC, has a similar take. “We don’t have a shortage of either quantity or quality,” he tells VCJ. “Are there some areas that are overpriced? Sure.”

But, with the exception of native AI solutions and market leaders, “everything else is way down, not only from where it was in 2020 and 2021 but also relative to the public markets,” Backus says.

Proof raised $135 million for its third and largest opportunity fund last year, as VCJ previously reported. Of the roughly 400 deals it is offered each year, it invests in about 10 of them.

Private market valuations tracked those of public companies fairly closely until 2020. Since the market correction in early 2022, which took down public and private companies alike, public company valuations have rebounded dramatically while private ones have not, says Backus.

“I think we’re at a point in time now where there’s a unique gap between private and public market valuations that will correct at some point in time,” he notes. “So I can’t understand why someone would say they can’t find enough good deals to invest in. They’re out there.”

It’s not as if CRV has lost its talent or appetite for backing winners. Three of its partners made this year’s Midas List by Forbes for best-performing deals: Murat Bicer for his investment in Datadog, Saar Gur for DoorDash and Max Gazor for Airtable.

“I applaud [CRV] for returning capital that they don’t feel that they have a good use for. I think that’s admirable,” says Drant of Questa. “We all have a target-return threshold, and if you don’t think you can hit that with a given strategy, then I think devoting less capital to it is a good idea.”

Questa pulled the plug on its second opportunity fund, Questa Capital Opportunities II, in late 2022 upon realizing it had enough capital in its primary funds to support follow-on rounds for its best-performing companies.

Most of the LPs that had already committed redirected their capital to Questa’s flagship Fund III, which closed on $400 million. But some that had invested specifically in the opportunity strategy chose to be released from their commitment, says Drant.

“Many LPs, when they see an opportunity fund, they think kind of lower risk, maybe a little lower return but an enhanced IRR, shorter hold [period] – those sorts of things,” Drant tells VCJ. “Certainly, there were some LPs where that had been their reason for investing, so we just released them from their commitment.”

For LPs investing in a typical opportunity fund, “the expectation will be you’re going to be investing at a higher price than your initial investment and sort of by definition the return will be somewhat lower,” Drant adds.

He wonders, in view of the “massive expansion of capital-raising between the late teens and 2021, particularly in tech, did that total fundraising overshoot the number of good places there are to invest that capital? And I think the answer to that is ‘yes,’ and I think that’s what CRV is saying, and that makes some sense to me.”

Drant notes the difference between the $393 million fund that CRV closed in 2014 and the combined $2.2 billion that it raised subsequently across three primary funds over the next nine years, not to mention a combined $700 million in two select funds.

“There’s a lot of firms that grew at that rate,” he says. “Maybe what [CRV is] saying is that part of the market is oversupplied with capital, and that wouldn’t surprise me.”

When is it prudent to shut down a vehicle for follow-on investments in your portfolio’s proven winners and opt to return unused capital to your limited partners?

That’s what CRV, based in San Francisco, has announced it is doing with the remaining $275 million in its second Select Fund, which closed on $500 million in 2022. Founded in 1970, CRV invests in the life sciences, consumer products/services and enterprise sectors.

In a recent Medium post (registration required), CRV says it has been closely monitoring the markets and its own portfolio over the last 18 months. “We raised Select Fund I ($200 million) in 2020 and Select Fund II ($500 million) in 2022,” it writes. “At the time, public market comps supported venture-like returns in later-stage rounds of our best companies. Between 2022 and 2023, we saw an adjustment taking shape, and it became more difficult to justify those returns.”

This isn’t the first time CRV has returned unused capital to LPs. It raised $1.2 billion for its flagship Fund XI back in 2000, but ultimately returned $750 million to investors two years later in the wake of the dot-com bust.

CRV partners declined to speak with Venture Capital Journal for this article, citing time constraints during a week of meetings with founders.

But a few other VC managers who have raised follow-on vehicles say they don’t share CRV’s concerns about inadequate returns on their investments.

Ryan Drant, founder and managing partner at Questa Capital, tells VCJ he isn’t finding it hard to get attractive valuations when investing in the later rounds of Questa’s strongest portfolio companies.

John Backus, co-founder and managing partner of Proof VC, has a similar take. “We don’t have a shortage of either quantity or quality,” he tells VCJ. “Are there some areas that are overpriced? Sure.”

But, with the exception of native AI solutions and market leaders, “everything else is way down, not only from where it was in 2020 and 2021 but also relative to the public markets,” Backus says.

Proof raised $135 million for its third and largest opportunity fund last year, as VCJ previously reported. Of the roughly 400 deals it is offered each year, it invests in about 10 of them.

Private market valuations tracked those of public companies fairly closely until 2020. Since the market correction in early 2022, which took down public and private companies alike, public company valuations have rebounded dramatically while private ones have not, says Backus.

“I think we’re at a point in time now where there’s a unique gap between private and public market valuations that will correct at some point in time,” he notes. “So I can’t understand why someone would say they can’t find enough good deals to invest in. They’re out there.”

It’s not as if CRV has lost its talent or appetite for backing winners. Three of its partners made this year’s Midas List by Forbes for best-performing deals: Murat Bicer for his investment in Datadog, Saar Gur for DoorDash and Max Gazor for Airtable.

“I applaud [CRV] for returning capital that they don’t feel that they have a good use for. I think that’s admirable,” says Drant of Questa. “We all have a target-return threshold, and if you don’t think you can hit that with a given strategy, then I think devoting less capital to it is a good idea.”

Questa pulled the plug on its second opportunity fund, Questa Capital Opportunities II, in late 2022 upon realizing it had enough capital in its primary funds to support follow-on rounds for its best-performing companies.

Most of the LPs that had already committed redirected their capital to Questa’s flagship Fund III, which closed on $400 million. But some that had invested specifically in the opportunity strategy chose to be released from their commitment, says Drant.

“Many LPs, when they see an opportunity fund, they think kind of lower risk, maybe a little lower return but an enhanced IRR, shorter hold [period] – those sorts of things,” Drant tells VCJ. “Certainly, there were some LPs where that had been their reason for investing, so we just released them from their commitment.”

For LPs investing in a typical opportunity fund, “the expectation will be you’re going to be investing at a higher price than your initial investment and sort of by definition the return will be somewhat lower,” Drant adds.

He wonders, in view of the “massive expansion of capital-raising between the late teens and 2021, particularly in tech, did that total fundraising overshoot the number of good places there are to invest that capital? And I think the answer to that is ‘yes,’ and I think that’s what CRV is saying, and that makes some sense to me.”

Drant notes the difference between the $393 million fund that CRV closed in 2014 and the combined $2.2 billion that it raised subsequently across three primary funds over the next nine years, not to mention a combined $700 million in two select funds.

“There’s a lot of firms that grew at that rate,” he says. “Maybe what [CRV is] saying is that part of the market is oversupplied with capital, and that wouldn’t surprise me.”