For most of the last fifteen years, the venture capital model didn’t need to justify itself particularly hard. When the risk-free rate was near zero, almost any venture return looked attractive on a relative basis. A fund could lose money on most of its investments and depend on one or two outlier exits to make the portfolio work. LPs tolerated this because the alternative, parking capital in Treasuries at half a percent, was equally unattractive.
That calculus has changed. With Treasuries above 4%, the median venture fund now has to justify not just its fees and carry, but its risk premium against a genuinely competitive risk-free alternative. And the data increasingly shows that most funds can’t do this.
The standard venture fund charges 2% management fees and 20% carry. On a $100 million fund, that’s $2 million per year in fees before a single dollar of return is generated. Over a ten-year fund life, $20 million goes to fees alone. For the carry to kick in, the fund needs to return the committed capital plus a preferred return hurdle, typically 8%. In a zero-rate world, that hurdle was soft. In a 4%+ rate world, the LP is comparing that hurdle against a Treasury that delivers half of it risk-free, with daily liquidity and no lock-up.
The maths gets worse when you look at median fund performance rather than top-quartile. Cambridge Associates data consistently shows that the median venture fund barely outperforms public equities on a net-of-fee basis over most vintage years. The outperformance that does exist is concentrated in a small number of top-performing funds, and persistence in those top quartiles is weaker than the industry likes to admit. If you’re an LP choosing between the median venture fund and a diversified public equity portfolio with a Treasury overlay, the venture allocation becomes very hard to justify on pure risk-adjusted terms.
I think the uncomfortable truth is that the traditional VC model, for the majority of practitioners, has been a negative-alpha product subsidised by low rates. Not all funds, obviously. But enough that the industry-wide numbers don’t look great once you give LPs a real alternative.
The standard response from the venture community is that rates will come back down, or that venture is a long-duration asset class and short-term rate movements don’t matter. I don’t find either argument convincing. On rates, the post-GFC era of near-zero policy rates was historically anomalous. The current rate environment is closer to the long-run norm. And on duration, the argument that short-term rates don’t matter ignores the fact that LPs rebalance portfolios continuously, and opportunity cost is calculated against whatever the current risk-free rate happens to be, not some theoretical long-run average.
What interests me is that this isn’t a cyclical problem waiting for rates to come back down. It’s structural. And structural problems tend to demand structural responses, not just better execution of the existing playbook.
The parallel I keep coming back to is private equity in the 1990s. PE went from financial engineering and leverage to operational value creation and portfolio management. It wasn’t that the old approach stopped working entirely. It’s that the environment changed enough that the old approach stopped being sufficient for most players. The firms that thrived were the ones that developed genuine operational capabilities rather than relying purely on financial structure.
I think venture is at a similar inflection point. The response will look less like “better deal flow” or “smarter investors” and more like a fundamentally different relationship between the investor and the company being built. One where the institution creating the venture takes on more of the operational risk, more of the early-stage de-risking, and earns its premium through systematic capability rather than selection skill. What that institution looks like is, to me, the most interesting question in venture right now.