Venture capital firms raise money — lots of it — and invest it in start-ups in hopes of generating big returns. One thing they rarely do is give the money back.
Yet that is what CRV, one of the industry’s oldest firms, is planning. The firm will tell its investors this week that it will return the $275 million that it has not yet invested from its $500 million Select fund, which is designed to back more mature start-ups.
The reason, four of the firm’s partners said in a joint interview, is that market conditions have changed for the worse. The valuations for start-ups are too high relative to their potential for a payoff, the partners said.
CRV’s decision is part of a reset that is happening around the venture capital industry after the go-go years of the pandemic. In 2020 and 2021, many start-ups and investment firms raised outsize funding, expecting the boom to keep going.
In the years since, the tech exuberance faded, and many start-ups cut staff or shut down. The market for initial public offerings and acquisitions — the main ways venture capital firms earn a return on their investments — has also been dismal.
Venture capital has always experienced booms and busts, but now, the boom and bust seem to be happening at the same time. While I.P.O.s have been infrequent and it has been hard to make strong returns for some investments, there is a frenzy to put money behind new artificial intelligence ideas.
It is a paradox that explains why CRV is plowing ahead with a fund for very new start-ups and pulling back on investing in the later rounds of more established outfits.
In 2022, CRV raised a $1 billion fund for young start-ups and $500 million for the Select fund, its second fund for more mature companies. The firm said it needed more money to accommodate the bigger investment rounds, higher valuations and the frequency of fund-raising.
But over the past year, CRV’s partners realized that they were passing on lots of investment opportunities for older, more mature companies for its Select fund. The reason was the math no longer worked. CRV does not plan to raise another Select fund.
In order to generate the kind of returns that CRV’s investors expected, many start-ups — far more than ever before — would have to wind up being worth $10 billion or more.
“The data just doesn’t support that,” said Saar Gur, a partner at the firm. “There aren’t many really big foundational companies and big outcomes.”
If CRV kept investing at current prices, Mr. Gur said, it would wind up with lower returns. So instead of settling for worse performance, the firm decided to cut the fund.
CRV will continue investing out of its $1 billion main fund and is roughly two-thirds invested. The firm has signaled to its investors that its next fund is likely to be smaller.
CRV was founded as Charles River Ventures in 1970 with the purpose of investing in companies built using research coming out of the Massachusetts Institute of Technology. The firm opened an office in Silicon Valley in 1999, changed its name to CRV in 2014 and moved fully to the West Coast in 2021.
This is the second time the firm has cut its fund size. In 2002, after the dot-com bubble broke, CRV slashed its $1.2 billion fund to just $450 million. Other firms, including Mohr Davidow Ventures and Kleiner Perkins, made similar moves that year in an admission that the hype had surpassed reality for many early internet start-ups.
This time around, fewer firms have been cutting. But some have admitted that the market conditions have changed and may no longer fit their strategies. K9 Ventures, which invests in very young companies, decided not to raise another fund this year because of changes in the market. Countdown Capital, a firm focused on hardware start-ups, shut down this year for similar reasons.
Kyle Stanford, an analyst at PitchBook, a provider of investment data, said that it was rare for venture capital firms to cut their funds, but that such a move could create good will among a firm’s investors, particularly when few are seeing returns in the form of I.P.O.s or acquisitions.
“For some of these mid- to large-size funds that have maybe added more funds to their strategy than they should have over the last few years, it’s probably a good move,” he said.
CRV has been discussing the challenges of the market with some of its investors, known as limited partners, over the last year. They were enthusiastic about the idea of getting rid of its Select fund and focusing only on the youngest companies, said Murat Bicer, a CRV partner. “We got literal high-fives in the meeting,” he added.
Some limited partners have been frustrated with the expansion of venture capital funds in recent years. In 2021, 28 firms raised funds of $1 billion or more, up from just eight such funds five years earlier.
There is an incentive for venture capital firms to raise bigger and bigger funds, since they typically charge a 2 percent management fee. Larger funds means larger fees, regardless of how well the investments do.
But bigger funds also tend to have middling investment performance. Smaller venture capital funds have historically minted the highest returns, according to data from Cambridge Associates, an investor in venture capital funds since the late 1970s.
Many of CRV’s limited partners have backed the firm for decades. Lawrence Rusoff, a managing director at Performance Equity Management, said other venture capital firms had been talking about the issue of venture capital funds that get too big. But so far, only CRV has opted to return any money.
“I view them as a leader in the industry related to this,” he said.
CRV’s decision will free up cash for Performance Equity Management to make more investments, Mr. Rusoff said. It is also more aligned with his firm’s strategy of backing firms that invest in very young companies.
The move could even help conversations with start-up founders. Venture capital investors often tell their portfolio companies to stay disciplined and not raise too much money. That message is easier to deliver when you’ve followed your own advice.
“Do what you’re good at,” said Reid Christian, a partner at CRV. “That’s exactly what we’re doing.”
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