Why Are Major Venture Capital Firms Becoming Private Equity Firms?

Andreessen Horowitz was not the first venture capital (VC) firm to file as a Registered Investment Advisor (RIA) five years ago, but it was one of the most prominent. Since then, a handful of others have followed including Lightspeed Ventures (Lightspeed), which thereafter announced a $7 billion fund to invest in secondary deals and artificial intelligence (AI).

What is driving this trend? Why do some of the biggest names in venture capital seem to be diversifying away from the model they helped to create? This article examines the strategy behind firms becoming multi-strategy conglomerates, and why it is about more than just a low-exit environment or limited partners fighting for liquidity.

Since the inception of VC and private equity (PE) firms, there was little crossover in their investment strategies. VC firms focused on startups, early-stage companies, and small businesses while PE firms invested in larger, more established companies. Those defined investment lanes are converging as VC firms have had to adapt to market changes, seeking additional investment flexibility, ability to access secondary markets, and the needs and desires of their investors.

The RIA Strategy Revisited

Filing as an RIA with the Securities and Exchange Commission (SEC) is not a trivial decision, as it imposes a variety of costs. Furthermore, the SEC demands much more from RIAs than non-RIA VC firms. RIAs must serve as fiduciaries, maintain stronger records, and withstand more scrutiny including SEC examinations. Most VC firms exclude themselves from these rules by investing 80% of their capital in private companies via a limited fund that does not serve the public. There are approximately 30,000 VC firms and nearly all are exempt RIAs, serving their specific niche and not trying to compete with the larger, traditional RIAs.

New Strategies That Are Possible as an RIA

Early VCs Investing in Late-Stage and Public Companies

VC firms are expanding beyond their traditional focus on young high-growth companies. For example, one of the things Lightspeed did after becoming an RIA was to invest $2 billion into the AI foundation model company Anthropic. This would have been unthinkable in the past when VC firms focused only on early-stage growth companies. However, Lightspeed and other similar VC firms have started making “pick and shovel” investments that they believe will help shape the future of digital infrastructure. RIA status allows VCs to better adapt to a changing market as they can pursue growth wherever it arises. VC firms can expand their opportunities to generate return beyond early-stage companies to include more established companies and public companies. This is critical as the early-stage VC market is crowded and returns on those companies has been compressed.

Secondary Deals

In recent years, startups are developing with abundant amounts of private capital being provided from large funds (both VC and PE). As such, these startups do not need public funding and avoid public market volatility and additionally regulatory scrutiny. Traditionally, an initial public offering was the primary means of a VC exit but that market has slowed especially since the 2022 tech company downturn.

In a low-exit environment, VCs are interested in widening the definition of what constitutes a “successful exit.” The two-sided secondary deal market eases pressure for firms with deployed capital to allow limited partners to sell their shares and achieve the liquidity they desire. It also provides an investment opportunity for other RIAs that want access to the limited number of later-stage companies without participating in a round of financing. This strategy will only grow more valuable as VC backed portfolio companies stay private for longer.

Competing For New Capital

Registering as an RIA allows VC firms access to a broader range of capital sources. Some investors prefer or are restricted to investing with RIAs because they are more regulated and perceived as lower risk than traditional VC firms. Additionally, institutional investors, including pension and sovereign wealth funds, tend to favor safer, larger, and longer-term investments with larger fund managers. So, VC fund managers are raising growth funds with these types of investments to attract these investors.

VC Managers’ Desire for Control

Typically, VC firms purchase a minority stake in portfolio companies and have limited impact on the company’s results. Some VC firms are shifting their strategies to include greater operational involvement and influence over their investments akin to a PE firm. By registering as a RIA, VC firms can raise larger funds allowing them to make bigger proportionate investments in portfolio companies and to assert more control.

The Future of Venture Capital

VC firms that have filed as RIAs are changing the near-term landscape for startups. VC managers now face a marketplace which includes fewer exits via the public markets and less startup investment opportunities. They are also facing pressure from PE managers who are investing in traditional venture-backed companies, primarily in the technology sector, due to their attractive outsized returns. As such, VC firms are becoming more like their PE counterparts, blurring the traditional boundaries, as they seek to raise more capital, manage larger pools of assets under management and deliver stronger returns for their investors.

To learn more about how Citrin Cooperman’s Financial Services Industry Practice can assist VC and PE companies in diversifying their strategies, contact to Timothy Schnall or your Citrin Cooperman advisor.