3Q24 investment market update - Emerging Managers in trouble

European venture investment in 3Q24 did little to dispel founder anxiety over the funding outlook. Despite some encouraging signs of life in Q2, both deal value and deal count suffered a relapse in Q3. 2 years into a severe correction and there is still much uncertainty about any sustained recovery emerging.

Once more in Q3, the supply/demand balance tilted in favour of investors. But founders would be wrong to think that this is driven by the VC community somehow manipulating the market to their advantage. The reality is that VCs too are feeling great uncertainty about their own fundraising prospects. Capital flows into VC have been hit severely over the past 2 years as returns from exits have dried up.

The impact on VCs is so dramatic that some are now talking of a 'Venture Apocalypse'. The number of new funds raised has not only collapsed since 2022 but the distribution pattern - amongst different types of VC - has also changed significantly. Limited Partners have been channelling bigger percentages of their reduced allocations into established fund managers at the expense of emerging fund managers (those with 3 or fewer funds under their belts).

The result? A worrying contraction in the number of funds managers. One high profile VC in their recent annual letter to LPs put it very bluntly: "We continue to expect the extinction of as many as 30–50% of VC firms."

Founders creating funding plans for 2025 need to dial in hard to this changing landscape. Emerging Managers - whether they are located in the UK, Europe or North America - are a key feature of the European early-stage investment scene. If they are in trouble the knock-on effect will be significant.

When building target investor lists for funding campaigns, founders must pay even greater attention to which VC fund managers are still in the game and which ones are not. Over the coming quarters, many of the smaller players are simply going to get squeezed out.

Europe VC investment 3Q24

First, let's look more closely at capital invested by VCs into startups and the number of transactions now taking place.

After an encouraging Q2, many were hoping that investment momentum had started to pick up. But 3Q24 figures disappointed. According to the latest Pitchbook data for Q3:

• Deal value (the amount invested in startups) was only €11.3B, down 38% YoY and down 31% QoQ.
• Deal count hit 2,203 (estimated), down 8% YoY and down 13% QoQ.

Based on YTD figures of €41B invested so far in 2024, the full year should finish at around €55B. This will be down 9.7% from 2023 (€60.6B), which was already a collapse of 42% on 2022 (€104B).

Even so, 2024 projected figures will be slightly ahead of 2020 (€51.5B), which will take us back onto the 10-year growth trajectory we were experiencing prior to the extreme highs of 2021/22.

But the feel-good factor at founder level is not the (modest) long term growth of the overall $ market per se, but the number of investment deals. This gives a truer sense of the chances of closing a funding round. Projected deal count for 2024 looks like it will be in the region of 10,000, the lowest number since 2018.

In other words, the long term trend is towards larger average deals sizes and this favours larger funds. This points again to a shift towards more established funds and a more challenging landscape for emerging managers.

European VC fundraising

So, how are emerging managers coping? Let's look at capital being raised by VCs.

After tumbling 30% YoY in 2023 the funding market for VCs has stabilised. European VC fundraising sits at €17.6 billion YTD, a run rate that implies 2024 will end 4.8% higher YoY. However, fund count will be down sharply and is expected to finish at the lowest level for over a decade.

As Pitchbook points out "The median fund size in Europe has increased to €83.7 million YTD, compared with €60.1 million in 2023. However, the median time to close and the time between funds continue to tick higher to 20.7 months (22.9% higher than in 2023) and 3.2 years (14.6% higher YoY), respectively."

For 2024 to date, capital allocations from LPs remain skewed toward experienced firms (managing the larger funds) despite more emerging firms in the ecosystem. 64.8% of capital raised YTD has come from experienced managers; however, 66.7% of funds in Europe were from emerging firms.

"First-time VC funds [in particular] are therefore showing less resilience, with €1.8 billion of capital going into such funds YTD, a run rate that puts the funds on pace to fall 30.8% below their 2023 total."

It's clear that there is a huge squeeze on emerging managers in Europe. Does that mean that European founders might find greater joy with North American investors? Sadly not...

North America VC fundraising

Three quarters into 2024, $65.1 billion has been raised across 380 VC funds, according to Pitchbook. "Annualized venture fundraising value is on track to exceed 2023 and pre-pandemic (2020) levels. Fund count, on the other hand, is projected to land at the lowest level in nearly a decade."

Even though fundraising by VCs is on track to narrowly exceed 2023 levels (just as it is in Europe), established managers are taking the lion's share of LP allocations. According to Pitchbook, just 2 funds (a16z and General Catalyst) have vacuumed up 44% of the total LP capital committed to US VC funds since the start of the year.

Historically, established managers garner a larger share of total capital raised per year. As of Q3 2024, $52.9 billion, or 81.2% of capital raised so far this year, was secured by established GPs, pointing to the highest level of concentration within this cohort in a decade.

Through 3Q24, $45.5 billion, or 69.9% of capital raised so far this year, belonged to funds that are $500 million or larger. First-time and emerging managers - most of which tend to have smaller fund sizes - are bearing the brunt of the fundraising slowdown.

Pitchbook states: "Reacting to the harsh reality of the liquidity crunch, many GPs have delayed their next fundraise to 2025 and beyond in hopes of waiting for overall market conditions to improve. By doing so, GPs also buy themselves time to improve their fund metrics.

"Not only are fewer managers back in the market, but the timeline for closing a fund for those actively fundraising has also elongated. The median and average times to close for US VC funds has ticked up to 14.7 months and 17.0 months, respectively, both the highest in our dataset."

Are Emerging Managers DOA?

Highly respected VC Frank Rotman of QED Investors is a voice that the VC community listens to. In a recent post he analyses the plight of emerging managers - and their potential survival strategies. This is an excellent read for founders looking for greater insight into the state of the VC ecosystem.

His message for emerging managers: "The writing is on the wall: adapt or perish. The days of simply working hard and expressing a desire to LPs that you deserve to be a VC are long gone. Today's landscape demands true differentiation and specialized skill. Emerging Managers will do best if they position themselves firmly within one of two key boxes: The Solo VC or the Non-Consensus Alpha seeker. Hunting in thematically consensus spaces or chasing serial Founders with many options is a good way for an Emerging Manager to fail."

He says that emerging managers will need to be incredibly crisp in articulating their differentiation and path to victory. "For Solo VCs, this might involve showcasing their track record of successful exits, their deep industry connections, or their ability to provide hands-on operational support. For Non-Consensus Alpha seekers, it could mean demonstrating their thesis-driven approach to identifying overlooked opportunities, their unique deal flow sources, or their ability to help Founders navigate from non-consensus to consensus."

In sum he says that undifferentiated firms won’t survive the current wave of consolidation and will be culled from the ecosystem by being starved of LP capital.

The big takeaways for founders

• Uncertainty over raising the next fund has forced many VC investors into zombie mode. They are preserving cash and only (very cautiously) investing in existing portfolio companies.
  
  
• Clearly align funding plans with investors that are adapting to the changing landscape. Pay particular attention to emerging managers. Increase investor due diligence. Target investors that are still actively investing through 2024, as well as successfully raising new funds.
  
  
• This extra due diligence takes time. Start the funding preparation process well ahead of any campaign launch date. Study The Four Zones of Risk to understand where others have made mistakes that you should avoid.

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