Talking about the bear market of encrypted VC layout: False book profits, the increasing demand for refund from invested companies.

First, we need to define two important metrics.

DPI (Distribution of Invested Capital). This is the cash distributed to LPs after deducting management fees and performance fees. It is the most important metric for LPs so far, because it cannot be fabricated and is the most accurate measure of fund performance.

TVPI (Total Value to Paid-in Capital). This is the value of the fund's assets calculated at market prices, also known as "book returns". Venture capital firms have a great deal of discretion in how they mark their assets (see below), so TVPI is often inflated. Excellent LPs are easily able to dig deep and see through false TVPIs during due diligence.

1. Most funds with higher TVPI have lower DPI.

This is what Chamath describes as the famous "VC Ponzi scheme," showing LPs your book returns in order to raise large mega-funds and earn hefty management fees.

Especially in the cryptocurrency field, venture capitalists have a lot of leeway in how they account for their investments. For example, a venture capital firm invests in a project that launches tokens with a lock-up period of several years and low liquidity on exchanges. Many would choose to mark their investments at the current spot price of the tokens without any discount, even though they cannot sell the tokens to realize such returns. Therefore, this is why new shiny L1 VC chains continue to raise funds.

Therefore, the prudent approach is to achieve good DPI over time to show that your returns are real. It's great to have a high TVPI, but you should let it fluctuate with the market and write down your investments at the appropriate time.

2. Most funds from 2017-18 have DPI lower than a16z Crypto Fund I's DPI.

Obviously, I can't share the exact numbers, but a16z made the fund size X times is very impressive.

a16z is a great brand and for large institutional LP investment committees that need to reach consensus on decisions, investing in a16z is like "no one gets fired for choosing IBM".

For other lesser-known funds, if their returns could be worse, LPs would also have to bear more reputation risk, so why should LPs choose them over a16z when a16z is an option? This is particularly true for individual GPs currently raising second funds and having poor performance in their first funds.

3. One-year funds in the 2021 bull market are among the worst performing funds.

A one-year fund refers to a fund that quickly raises and deploys all capital within one year and then raises the next fund in the second year. By asking institutional LPs who have been investing in the venture capital space for decades, I couldn't find any historical cases of one-year venture capital funds performing well.

Any institutional LP will tell you that the most important factor in fund returns is vintage year, not the ability to get good deal flow or pick good companies. But as a venture capitalist, you can't control the macro environment. Your job is to find the best founders and themes in your domain of expertise and deploy slowly across multiple vintages to diversify macro risk.

For cryptocurrency venture capital, 2021 has been a particularly bad year. Seed funding was completed at valuations of over $50 million before product launch, with risk/reward meaning nothing. So many startups are raising funds that VCs feel the pressure to deploy capital. Moreover, startups are doing subsequent funding rounds in short periods of time, which forces early investors to exercise their equity proportionally to maintain their ownership percentage before seeing meaningful product traction. This leads to a faster deployment of venture capital than expected and a quicker return to LPs to raise the next round of funds.

4. It's either small seed funds or large index funds, with nothing in between.

This is a good example of dialectics (the truth of opposites at extreme cases). Seed funds are "snipers" that become the first money into startups at attractive valuations, and in this case, risk/reward means that the fund only needs one successful seed investment to see a return. Large funds, on the other hand, are like "aircraft carriers" that manage the market in a indexed way and have meaningful ownership in companies after most are public.

Fund size tends to be a legitimate signal of competition for venture capital firms. Up-and-coming fund managers feel the pressure from their peers, and they want assets under management in the billions of dollars, but the fund size game tends to favor existing brands. Seed funds that raised larger funds in unconstrained fashion during the bull market are currently caught in the middle, too big to get upside from seed investments and too small to become a well-known brand. They aren't able to raise funds of that size again in the short term, and reducing the fund size would lower management fees.

Just because you can raise a larger fund doesn't mean you should.

5. Unfortunately, in bear markets, it is becoming more common for VCs to pull out of term sheet agreements and request refunds from the invested companies.

Pulling out a term sheet means that venture capital firms have agreed to invest under certain terms, but during the waiting period for legal documents to be completed, the cryptocurrency market crashed, causing VCs to back out of deals. This doesn't mean that VCs had actually signed the documents; refer to YC's handshake agreement as an example of what is considered an industry standard. However, this sets founders back by months, as they must waste time raising funds again in a worse environment.

Requesting refunds from portfolio companies means that VCs funded the companies in the bull market but now regret it and want their money back. This isn't as bad as pulling out of term sheets because founders are obviously not obligated to agree to the refund, but it still tarnishes the VC's reputation of being "founder-friendly."

So far, I've heard of five prominent cryptocurrency venture capital funds doing this from founders and other investors. The worst offenders have done this to at least five different companies. I also noticed that the more VCs are invested in public image, the more they feel they can get away with such bad behavior behind the scenes.