Venture funds typically aim to return capital to investors within 10 years, although disbursements can begin as early as year five or six. In the first 2-3 years, the fund manager generally focuses on investing and growing the portfolio. An exit can be an IPO, an acquisition, a liquidation event, or a SPAC merger.
Let's unpack time horizons a bit more.
Why are venture funds generally 10 years?
Funds make money when a portfolio company exits. The 10-year time horizon gives venture funds enough time to invest in and grow a portfolio company until it's ready to exit. For example, the typical company takes 6 years from initial venture funding to IPO. A SPAC is a cheaper, faster alternative to a direct IPO, but not all companies are suited for this type of exit.
An analysis sponsored by the Duke Financial Economics Center finds that M&As are faster than IPOs, taking 5 years on average from initial venture funding to exit.
Since these are median timelines, some companies will take longer, and some will exit faster. But the 10-year time horizon gives venture funds a good chance of seeing investment returns.
What are long-term funds?
A retail investor might find 10 years to be a long time to wait for returns, but it's relatively short-term for institutional investors like pension funds and endowments. These investors are looking for stability and capital preservation. As a result, they often invest in longer-term funds, with time horizons of 15 to 20 years.
In fact, an INSEAD report has found a surge of general partners (GPs) raising these longer-dated funds. Large PE firms like The Carlyle Group and Blackstone are launching buyout funds with extended holding periods.
These funds benefit from longer "lock up" periods, in which investors agree not to redeem their shares for a certain number of years. This gives the GP more time to deploy capital and generate returns.
Do short-term funds exist?
While 10 years is a common time horizon for venture funds, some are just 8 years or less. Shorter time horizons can lead to more pressure on GPs to exit early, which may not be in the best interests of the portfolio company. This can result in sub-optimal outcomes, like "fire sales'' of portfolio companies.
Similarly, longer time horizons can give GPs more flexibility to invest for the long term and wait for the right exit. This can lead to better outcomes for investors and portfolio companies alike.
Another reason shorter time horizons can be sub-optimal is the J-curve: a typical venture fund's returns start negative in the early years, as expenses are paid, and initial investments are made. It usually takes several years for the fund to begin generating positive returns. If a fund has a shorter time horizon, investors may not give it enough time to mature and produce optimal results fully.
A Fidelity analysis finds that short-dated bonds, unsurprisingly, tend to underperform their indices more than their all-maturity counterparts. Bond investors should also consider the appropriate time horizon for their investment objectives.
Understanding short-term liquidity
Many venture funds also return capital to investors through "early distributions." Secondary markets also provide liquidity for investors who want to sell or acquire new stakes in venture-backed companies.
Asset-based lending can enable this type of liquidity by providing loans against the value of stakes in private companies.
Ultimately, time horizons are an important consideration for venture funds and investors. Shorter time horizons can lead to sub-optimal outcomes, while longer time horizons can give GPs more flexibility to invest for the long term.