Why the vintage year of a venture capital firm can determine its overall success
A vintage year is the year in which a firm forms and closes a venture capital fund. There are periods of time when many great companies are born, such as 2008 when Square, Stripe, CreditKarma, NerdWallet, Uber, Airbnb, WhatsApp and Instagram were all started, among others. This made 2009 a great vintage year for venture capital, despite massive global economic challenges with the collapse of Lehman Brothers.
Vintage Year Importance
The vintage year is often the single most vital factor affecting the success rate of a venture capital fund. As an example, a favorable vintage year can yield up to a 5x return for a top performing fund, whereas an unfavorable one might deliver only a 2x return.
Several factors affect the quality of a vintage year, determining whether it is favorable or unfavorable for venture capital firms:
Economic Fluctuations: The state of the economy, including downturns and booms, can significantly influence the success of venture firms. Economic downturns often result in higher venture capital returns.
Talent Availability: The presence of talented entrepreneurs and skilled workforce can enhance the performance of venture firms. Years with high talent availability tend to yield better returns.
Funding Availability: The availability of funding also impacts the performance of venture capital firms. Years with high funding availability can lead to high performing ventures, but also lean years have been historically high performing for early stage.
Technological Innovations: The emergence of new technologies create opportunities for venture firms. Years marked by significant tech innovations often produce high venture returns, such as the advent of the internet or mobile.
The performance of venture firms varies significantly from year to year. As an example, a top-performing fund from one vintage year might underperform compared to an average fund from a superior vintage year.
2023 Vintage Year
The year 2023 is predicted to be a top vintage year for venture capital firms because many of the ideal market conditions are met. Many venture capitalists are predicting 2023 to be one of the best vintage years in history. This prediction stems from a unique confluence of factors:
Pandemic Aftermath: The world is emerging from the COVID-19 pandemic, giving rise to new opportunities across various sectors. In addition, humanity is coming back to work with higher productivity levels.
Market Downturn: Historically, market corrections have coincided with substantial vintage years. The recent correction in the market is creating a favorable environment for venture capitalists.
Lower Valuations: Accompanying the market correction, lower valuations of startups present an opportunity to invest at reduced costs. Lower investment costs increase the potential for higher returns.
The Great Resignation: An influx of skilled professionals, due to pandemic-related job disruptions, has created a talent-rich environment. This situation enhances the chances of venture firm success.
Remote Work: The surge in remote work has broadened the geographical reach for venture capitalists. With this, they can tap into startups and talent worldwide, thus increasing investment prospects.
Artificial Intelligence: The steady rise of Artificial Intelligence presents a new frontier for investment. High returns are likely for venture capitalists investing in this transformative technology.
Early Stage Capital: The recent increase in early-stage capital provides venture capitalists an opportunity to invest in startups at an early stage, gaining higher equity stakes.
Given these promising conditions, aspiring venture capitalists seeking high returns should consider establishing their funds in 2023. It is well known that venture capital is countercyclical, as of Q3, 2023, the recovery in the wider economy and in venture capital are well underway.
Targeting a Vintage Year
Entering into a particular vintage year requires meticulous planning and effective execution. These processes can take several months, therefore starting early is critical. The steps to be in a desired vintage year involve:
Finalizing a Thesis: This is the initial step, where you crystallize the investment strategy. The thesis should outline your approach to identifying and investing in potential startups.
Creating Fund Materials: Once the thesis is set, the next step involves creating pitch decks, financial models, and due diligence materials. These resources will be essential for attracting potential limited partners (LPs).
Developing Investment Plans: Establishing a concrete sourcing and investment strategy is important. Winning funds back companies that get fast markups and large cash on cash returns.
Attracting Initial Limited Partners: Fund formation normally begins after the manager secures 10+% of the fund in interest from limited partners. This can sometimes take a hundred meetings, as well as follow up.
Securing Formation Vendors: Vendors for legal, back office, banking, tax, and other aspects of fund formation need to be secured. Selecting the right vendors takes time, and many are very busy.
Starting the Formation Process: Once vendors are secured, the fund formation process begins. This process involves multiple steps, from establishing the legal entity to preparing and finalizing the Limited Partnership Agreement (LPA).
Completing a Close: The process concludes with the final close, where the limited partners sign the LPA and commit their capital to the fund. This step marks the formal establishment of the fund.
Initiating a Capital Call: The final step is to call initial committed capital from the limited partners, officially marking the vintage year.
Given the lengthy nature of these processes, starting early to establish the fund in the desired vintage year is highly recommended. The early start provides a cushion to handle any unexpected hurdles that might crop up during the process.
Potential Challenges
Venture capitalists aiming to establish their funds within a specific vintage year may face various challenges. These hurdles can delay the process and increase the complexity of the fund formation. Some of the potential challenges are:
Vendor Delays: Vendors can sometimes be slow in delivering their services. Additionally, mistakes on their part can lead to extended timelines and potential complications.
Limited Partner Issues: Limited partners can be slow in their commitments. There could be instances of second thoughts or even withdrawals that can disrupt the formation process.
Team Breakups: The stress associated with the closing process, especially fast closings, can cause disagreements among team members and lead to breakups, which can delay the process.
Thesis Iterations: Crafting the right investment thesis that resonates with limited partners is a lengthy, iterative process. It can take months to fine-tune the thesis, which might cause delays.
Legal Complexities: Navigating the legal landscape of fund formation can be challenging. Misunderstandings or disagreements about the Limited Partnership Agreement can prolong the formation process.
Market Disruptions: Any unexpected disruptions, such as sudden economic changes or personal emergencies, can lead to delays and complicate the process.
These challenges underscore the importance of early planning and meticulous execution. Being prepared for such potential obstacles can help venture capitalists establish their fund within their target vintage year.
Conclusion
The vintage year significantly impacts the success of a venture capital firm. By planning well and starting early, a venture firm can optimize its chances of establishing in a favorable vintage year, like 2023 is predicted to be. For those seeking to capitalize on the 2023 vintage year, the fund launch process needs to start now.
There are a few slots still open on VC Lab Cohort 12, which is specifically designed to get funds closed in the 2023 vintage year.
Adeo Ressi is CEO of Decile Group, powering the next generation of venture capital firms worldwide with an integrated offering of training, tools, support, and funding. Decile Group is the parent of the VC Lab venture capital accelerator, which helped to launch nearly 50% of all new manager firms in 2022. Adeo is also Executive Chairman at the Founder Institute, a pre-seed accelerator with chapters in over 250 cities worldwide and over 5,000 portfolio companies.
Adeo has launched 14 venture capital funds and founded 11 startups, having nearly $2 billion in exits before 30. Adeo previously served on the Board of the X Prize foundation to pursue his interests in space exploration. He studied architecture and spent time living on a commune to explore his interests in designing better ways to live. Adeo is passionate about inspiring people to achieve their potential.
