US Venture Capital Report 2018 — The Megafund Era

The defining development in US venture capital in 2018 was scale. Fund sizes crossed a threshold at which the mathematics of venture investing changes, and the consequences reached every stage of the market.

The mechanism is direct. A large fund must deploy large cheques. A fund cannot deploy billions of dollars in $5m increments — the number of investments required would exceed what any partnership can source, diligence and govern. So a larger fund necessarily writes larger cheques, which means investing in later-stage companies or investing far more in early-stage ones than their stage would conventionally warrant.

When one participant can offer several times what any competitor can, and can offer it faster, price competition becomes ineffective for everyone else. A founder offered substantially more capital at a substantially higher valuation, with a shorter process, will usually accept.

The market responded with pre-emption: offering terms before a company begins a fundraising process, so that no auction occurs. This became standard practice in 2018 and never receded. It is now the normal mode of competitive investing.

Pre-emption has a consequence that is easy to miss. An auction is how a market discovers a price. Removing the auction means the price is set by a single bidder's assessment rather than by competition among bidders. That is not necessarily a worse price — but it is a price with no independent validation, which is exactly the condition the 2015 report identifies as the origin of the private-public gap.

Beneath the headline, a quieter structural change was underway: the bar for a Series A rose materially, and the share of seed-funded companies that reached one fell.

The mathematics of a large fund

Understanding why fund size changes behaviour requires understanding what a fund must return.

A venture fund aims to return a multiple of committed capital. Because venture outcomes are highly skewed — most investments return little, a few return a great deal — the fund's return depends overwhelmingly on its largest winners.

This produces a size constraint that is arithmetic, not stylistic. A fund needs its winners to be large enough, relative to its own size, to move the fund. A $100m fund owning 20% of a company that exits at $500m returns its entire fund from that one position. A $5bn fund owning 20% of the same company receives $100m — 2% of the fund. The same outcome, the same skill, and a completely different consequence.

Three things follow directly:

• Large funds require much larger outcomes to matter. Companies that would be excellent results for a small fund are immaterial for a large one.
• Large funds must own more of each company, or invest at higher valuations, to make the position meaningful. Both push toward larger cheques.
• Large funds concentrate into fewer positions, because governing hundreds of investments is impractical.

The market-level consequence is that large funds are structurally obliged to compete for the same small set of companies — those with the potential for very large outcomes. That concentration of demand onto a narrow set of assets is what drove valuations at the top of the market in 2018 and after.

A fund's size determines which outcomes can matter to it. That is arithmetic, and it determines strategy more reliably than any stated investment thesis.

There is a corollary that matters for LPs and is frequently obscured. A larger fund is not a scaled-up version of a smaller one. It is a different strategy with different return characteristics, run by the same team under the same brand. A manager whose record was built on a small fund is being evaluated on evidence generated by a strategy they are no longer running.

Pre-emption and the loss of the auction

Pre-emptive investing — offering terms before a company runs a process — became standard in 2018 and is worth examining as a price formation mechanism.

How a normal round forms a price. A company decides to raise, speaks to multiple investors, receives multiple offers, and selects among them. The price reflects competition: the winning bid is at or slightly above the second-highest assessment of the company's value. This is an auction, and its output is a price validated by multiple independent participants.

How a pre-emptive round forms a price. An investor approaches a company that is not raising and offers terms attractive enough to accept without testing the market. The company accepts because the offer is good and running a process is costly and distracting. The price reflects one investor's assessment plus whatever premium was necessary to prevent an auction.

The consequences run in both directions:

• The company gets a good price — usually better than a process would have produced, since the premium to prevent competition is the point.
• The investor gets the deal without competing, which is the entire objective.
• The price has no independent validation. No other participant assessed it.
• The information content of the round falls. A price set by an auction tells the market something about the company's value. A price set by one bidder tells the market about that bidder.

For anyone using round valuations as data — later investors, LPs assessing marks, other founders benchmarking — pre-emptive rounds are systematically less informative than competitive ones, and the data does not distinguish between them.

This connects directly to the 2021 report's description of the access market. Pre-emption is the fully-developed form of competing on speed rather than judgement, and 2018 is where it became normal.

Growth equity as a distinct discipline

The space between traditional venture capital and leveraged buyout became a defined category in this period, with its own funds, its own practitioners and its own standards.

Growth equity describes minority investments in companies that are already established — with real revenue, often profitability or a clear path to it, and a proven model — that need capital to expand rather than to prove a thesis.

It differs from venture on three dimensions:

• Risk profile. The primary question is execution and market size, not whether the product works or anyone wants it.
• Return expectation. Lower target multiples than venture, reflecting lower risk. A growth investor targeting 3× is not underwriting the same distribution as a venture investor targeting a fund-returning outcome.
• Diligence. Financial and commercial diligence resembling private equity — cohort analysis, unit economics, customer references at scale — rather than the judgement-led assessment venture applies to early-stage companies.

It differs from buyout in using little or no leverage and taking minority positions without control.

The emergence of this as a defined discipline mattered for a specific reason. A distinct return expectation implies a distinct valuation discipline. A growth investor targeting 3× over five years can compute the exit value required and work backward to a maximum entry price. That constraint is stricter than the one a venture investor faces, since venture accepts that most investments fail and relies on the outliers.

Where growth investors set the price, valuations were more disciplined. Where crossover investors applying public multiples set the price — the dynamic the 2021 report describes — they were not. Both were operating in the same stage of the market, using different frameworks, and the resulting prices reflected which framework won each round.

The Series A bar rises

A structural change occurred quietly in this period and is consistently misdescribed.

As the 2016 report describes, the seed market professionalised and expanded — more seed funds, more standardised instruments, more companies funded at seed. Meanwhile Series A rounds grew larger, as funds grew larger and stage definitions drifted upward.

Two consequences follow arithmetically:

• More companies received seed funding than in prior years.
• Each required more progress to raise a Series A, because a larger round demands more evidence to justify it.

The result was a falling conversion rate — the share of seed-funded companies that go on to raise a Series A. This was widely described at the time as a "Series A crunch", implying a shortage of Series A capital.

That description is mostly wrong. Series A capital was abundant. What had changed was:

• The denominator grew. More seed companies means more that will not convert, even at a constant absolute number of Series A rounds.
• The bar rose. A larger Series A requires more traction, so a company that would have qualified in 2013 did not in 2018.
• A new stage filled the gap. Seed extensions, seed-plus and pre-Series-A rounds emerged to serve companies between the two — the same downward stage replication the 2016 report describes.

The correct description is not a shortage of capital but a redefinition of a stage. The distinction matters because the two imply different responses: a capital shortage argues for more Series A funds, while a redefinition argues for building the intermediate stage that in fact emerged.

What fund size means for a limited partner

The observation that a large fund is a different strategy rather than a scaled version of a small one has consequences for LPs that are worth setting out, because they are frequently obscured by the continuity of the brand.

The evidence being relied on was generated by a different strategy. A firm's track record from a $200m fund reflects investments where a $50m outcome was material. The same team running a $2bn fund needs outcomes an order of magnitude larger for the same effect. The historical returns are evidence about a strategy the firm is no longer running.

The distribution of outcomes changes shape. A small fund can return capital from several good outcomes. A large fund requires at least one exceptional outcome, because good outcomes are immaterial to it. That makes the large fund's return distribution more dependent on the extreme tail, which is the least predictable part of it.

The competitive set changes. A large fund competes for a narrow band of companies with very large potential outcomes — and so does every other large fund. Concentration of demand onto a small set of assets raises prices for exactly those assets, which is the mechanism this report describes.

Fee economics change the incentives. A management fee on a larger fund produces substantially more revenue. A firm whose fee income alone supports the partnership has a different relationship to carried interest than one dependent on it. This is not an allegation of misalignment; it is an observation that the alignment mechanism weakens as fund size rises, and it is the reason LPs pay attention to fund size independently of strategy.

What an LP can reasonably ask:

• What outcome size does this fund need, and how many companies in the target market plausibly reach it.
• How many investments will the fund make, and what ownership will it target — which determines whether a good outcome is material.
• What proportion of the historical record came from funds of comparable size to the one being raised.
• What happens to reserves, since a larger fund's follow-on capacity changes how it supports companies and how much goes to new investments.

A fund's size determines which outcomes can matter to it. That is arithmetic, and it determines strategy more reliably than any stated investment thesis — including the firm's own.

What an allocator could act on

Distinguish pre-emptive rounds from competitive ones when reading valuations. A price set by one bidder without an auction has no independent validation. A price set by competition has been tested by several parties. Both appear identically in valuation data, and the first is systematically less informative. Where a mark is being relied on, knowing which it was is worth asking.

Check the Series A conversion rate against the cohort definition. A falling conversion rate can mean a capital shortage or a redefinition of the stage. These imply different responses — more Series A capital versus building the intermediate stage — and the data does not distinguish them without knowing whether the seed cohort grew and whether the Series A bar rose.

Watch for stage replication. As a stage institutionalises and its cheque sizes rise, a new stage forms beneath it. This has happened repeatedly — seed beneath Series A, pre-seed beneath seed — and it means that stage labels drift in meaning over time. A "Series A" in 2018 and a "Series A" in 2013 describe companies at different levels of maturity, which makes historical comparison by stage label unreliable.

Assess growth equity as a distinct discipline. Its return expectation is lower and its valuation discipline correspondingly stricter — a growth investor targeting 3× can compute a maximum entry price and work backward. Where growth investors set the price, valuations were more disciplined than where crossover investors applying public multiples did. Knowing which framework won a round tells you something about the price.

Treat the removal of the auction as a loss of information. The market-wide shift to pre-emption made reported valuations less informative as a class, not only in individual cases. Anyone using round valuations as data — later investors, LPs assessing marks, founders benchmarking — was working with a series whose information content had declined, and the decline is not visible in the data.

What 2018 established for US venture

• Fund size was shown to determine strategy arithmetically, and large funds were shown to be a different strategy rather than a scaled version of a small one.
• Pre-emption became standard, removing the auction from price formation and reducing the information content of reported valuations.
• Growth equity became a distinct discipline with a valuation framework stricter than either venture or crossover investing.
• The Series A bar rose, and the resulting conversion decline was widely misdiagnosed as a capital shortage.
• Stage replication continued, with intermediate rounds forming to fill the widening gap.