Dealmaker

By Kate Clark

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Sequoia Capital told its limited partners in a letter this morning that its divorce from its former Chinese and Indian affiliates—now known as HongShan and Peak XV Partners, respectively—was complete, according to a person familiar with the matter. We reported back in November that the split was all but finalized. The divestiture follows the growing geopolitical conflict between the U.S. and China and paves the way for more-direct competition between Sequoia and HongShan in particular. Find more details here. In other news... 

We didn’t even make it one week into the new year without a venture capital fund announcing that it’s shutting down. 

Jai Malik, founder of industrial startup–focused fund Countdown Capital, explained his decision to call it quits in a four-page letter to his limited partners this week. Not once did he mention the downturn in VC that’s made raising capital harder, nor did he talk about rising interest rates or layoffs. Instead, he spent paragraphs reflecting on how multistage funds with more firepower to go after early-stage deals are making it impossible for small funds like his to generate the returns they need. It’s a reminder that macroeconomic headwinds aren’t the only challenge plaguing the underdogs in venture capital. 

Malik told the investors that for his fund to be successful, it needs to invest in startups with a potential exit value of over $2.5 billion at entry valuations of $20 million or less. Unfortunately, three years into running his fund, he’s discovered that “businesses that meet these criteria are unlikely to exist.” That’s largely because bigger funds like Andresseen Horowitz and Founders Fund are bidding up valuations, and because the industrial sector, which includes defense and aerospace companies, has minted few winners to date. 

Malik also implies that the microfund model—funds that raise under $50 million and invest in a smaller number of companies, usually in a specific sector—is broken. He explains that even if Countdown had won early stakes in one of the top three industrial startups founded in the past eight years—Anduril, The Boring Company, and Redwood Materials, now all worth more than $5 billion—it would likely have had to put the majority of his fund in one company just to acquire a skimpy 3%. 

“It is no surprise to hear that some early-stage firms that invested in early rounds of these…companies have yet to return their funds while these companies have simultaneously been the most profitable for multi-stage funds,” he wrote. 

Rather than invest the remainder of his $15 million second fund in mediocre businesses, Malik decided to give the money back, TechCrunch was first to report. His firm will completely wind down by the end of March. Malik didn’t respond to a request for comment. 

Perhaps Malik, a former manager at tech companies Forge.AI and Accrete, should have realized sooner that trying to beat megafunds with such a tiny pool of capital and a scant track record was a futile pursuit. In his defense, the VC industry has transformed greatly since he started his firm in 2020. Despite a drop in VC fundraising triggered by spiking interest rates, the long-term trend is that a smaller group of firms will raise increasingly large funds. They’ll invest that money across all stages, all while dedicated early-stage firms with far fewer resources will try to win based on speed and expertise.

There’s long been a debate about the benefits of startups teaming with smaller specialty funds versus multistage behemoths. The core argument for the former group is knowledge and time. In the past, a seed fund’s investors knew a lot about getting a startup off the ground and could dedicate significant time to a founder. Bigger firms were more helpful once a company found a product-market fit and needed large checks, but generally had less need for midnight phone calls and mentorship. 

These days, however, large VC firms have moved onto early-stage firms’ turf, including  investing in talent to help companies at every stage. Small funds can’t afford to grow headcount, can't give in to higher valuations or invest in the “slick marketing,” as Malik describes it, that a firm like Andreessen Horowitz uses to win deals. The strongest firms are getting stronger and the likelihood of success for small, dedicated seed funds is shrinking. 

That said, it’s rare for a failed venture capitalist to admit to, and especially to outline, the pitfalls of their chosen strategy. Malik’s screed is likely to instill fear in the hundreds of other small fund managers who are in exactly the same position and who have likely also contemplated closing up shop.

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Venture capital is undergoing massive changes. Award-winning journalist Kate Clark tells you what's coming next for startup founders and investors.

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About Kate Clark

Kate Clark is deputy bureau chief responsible for venture capital coverage at The Information. She's the author of Dealmaker, a weekly column on VC. She is based in New York and can be found on Twitter at @KateClarkTweets. You can reach her via Signal at +1 (415)-409-9095.

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