Fear the Venture-Capital Walking Dead: The Rise of Zombie Funds

‘Deeeeeals. Deeeeeals.’ Zombie venture funds, which struggle to raise subsequent funding rounds, are likely to proliferate, participants in the DLD conference in Tel Aviv said.
AMC/Everett Collection

The talk among tech investors and entrepreneurs at the Digital Life Design tech conference in Tel Aviv is about the coming rise of venture zombie funds—venture-capital vehicles that deployed investors’ capital at peak valuations but can’t sell off at a profit.

While this has been going on in cycles of venture capital and private equity for years, close watchers of the tech-investment scene say there will be a wave of zombie funds in the next five years. A zombie fund is one that managed to raise its first funding round easily enough but will struggle to raise second or third rounds in coming years, because many of its portfolio startups will inevitably fail or underperform despite being flush with cash today.

Given the surrounding early-stage tech companies and the hordes of new fund managers without the necessary backgrounds, operational skills and networks to identify and create winners, a lot of these new VCs will be left with less-than-spectacular portfolios delivering subpar returns, said one former Morgan Stanley executive director. He asked to remain anonymous because he is raising money for his own fund.

According to data from Dow Jones VentureSource, of the 46 independent and corporate VC firms founded in Europe in 2011, 42 were still in operation through this past Aug. 31. But they’re making fewer investments: 389 in 2012, 252 in 2013, 57 in 2014, and only three as of the end of August this year.

In the U.S., investment is still increasing. According to VentureSource, the amount invested by VC firms in the first half of 2015 rose to $35.9 billion (1,960 deals) from $57 billion (3,906 deals) in all of 2014.

“We’re in a period of euphoria now. Get ready for a new wave of zombie VCs,” said Yossi Vardi, a serial Israeli entrepreneur and organizer of the DLD conference. “In 1999, there were about 100 venture-capital funds in Israel—they turned into zombies, and most are now gone.”

One of the reasons that venture-capital firms are taking big bets on startups that might not be their first or even second choice of investment: the entrance of new players in the startup funding market, including angel investors taking on bigger rounds, private-equity firms driving up valuations, and large corporations funding startups directly or through innovation accelerators—sometimes without taking equity.

There is also a trend of wealthy individuals without established tech-investing track records who are raising tech venture funds.

A Goldman Sachs investment banker who specializes in early-stage funding of tech startups in Silicon Valley said she had recently talked several of her friends out of raising their own funds.

But not everyone thinks the rush to start funds is a bad thing. Philipp Moehring, who leads the European business for AngelList, a network for startups and angel investors, said he met 20 people in one day in London who are all starting their own funds or joining new ones. But the difference from the Goldman Sachs example: most of these people have an investing track record. “Great people who now have years of experience can make faster decisions, try new things, build new structures,” he said.

Not to worry, there’s even a potential market for venture zombie funds: buyers who will take on the assets. And even venture zombies can rise from the dead, said Frederic Court, a London-based entrepreneur who this year raised a $120 million fund for new European startups.