Key Takeaways

  • Thirteen years of zero-interest-rate policy funneled excessive capital into venture investing, creating an oversupply of sub-par managers who failed to distribute cash.
  • Many firms classified as B-minus or worse missed the 2021 market peak to exit positions, locking their investors into non-performing paper.
  • Trapped managers now operate as fee-collecting zombie funds, riding out 10-year fund lifecycles because venture offers no graceful downward career exit.
  • Managers facing extinction are retroactively rebranding older enterprise and software portfolios as artificial intelligence investments to court fresh LP capital.
  • Selby estimates the asset class is only in the second inning of a multi-year liquidation cycle, far behind where market observers expected.

The Ten-Year Fee Trap

Thirteen years of cheap money warped the economics of venture capital. Capital rushed into private tech markets, ballooning fund sizes and encouraging managers to prioritize paper markups over actual cash distributions. When the exit window slammed shut after 2021, the bill came due. Firms that failed to sell portfolio companies at the top found themselves stranded with illiquid assets that public markets and strategic acquirers refused to buy.

“The industry has done a poor job of returning capital to its investors over the last decade,” (play from 0:35) Selby says. “And we can talk more about what that's the case, but that's just a fact.” (play from 33:03)

Instead of unwinding or taking hard write-downs, struggling managers chose survival. Fund documents typically guarantee a 10-year term with two one-year extensions. That contractual structure gives struggling general partners every incentive to keep funds alive solely to collect their two percent annual management fee.

“They're 10-year vehicles, and these venture firms that turn out to be B minus or worse just play the game of manage management fee ventures,” (play from 34:50) Selby observes. “And they just write it out, and they milk the fees, and they're zombies.” (play from 34:59)

In public equities or investment banking, underperforming dealmakers face quick demotions or layoffs. Venture has no comparable downward career track. A partner cannot easily step down to run a smaller fund or transition into a mid-level operating seat without taking a severe reputational hit. General partners cling to zombie funds because shutting down means leaving the asset class entirely.

The Artificial Intelligence Hail Mary

With DPI nonexistent and LPs closing their checkbooks to underperforming shops, zombie managers need a fresh story to justify raising their next vehicle. That desperation explains the sudden rush into artificial intelligence.

“So, you have a vintage of venture managers that are ostensibly still in business today, but they're walking zombies because they screwed up by not returning any capital to investors at the last cycle peak, which is back in 2021,” (play from 35:21) Selby says. “And now, so many of those folks have reinvented their portfolios as all being AI companies. So, if you had a wayback machine and looked at their portfolios from 5 years ago, you would not see nary a mention of AI.” (play from 35:34)

This retroactive positioning functions as a survival mechanism rather than a coherent strategy. Legacy SaaS and consumer investments are reframed as machine-learning plays in pitch decks. General partners use the current AI investment frenzy to distract institutional allocators from five years of flat distributions and unrealized paper gains.

A Cull Moving in Slow Motion

Most private equity and venture observers expected the shakeout to resolve quickly once interest rates rose in 2022. Selby admits he misjudged the pace of the purge, underestimating how stubbornly managers would hold on to fee streams.

“And I've been wrong about this because I've been pounding the table about this dynamic, and I would have thought if it was a baseball analogy, we would be in the fifth or the sixth or maybe even the seventh inning of this process,” (play from 36:18) Selby notes. “And the reality is, we might be in the second inning at best.” (play from 36:28)

The structural math guarantees that this liquidation will drag out. Funds raised between 2018 and 2021 still have five to seven years of contractual life remaining. As dry powder for follow-on rounds vanishes, these firms will stop supporting existing companies, leaving secondary buyers to purchase distressed positions at steep discounts.

Why It Matters

This dynamic signals that venture liquidity will remain constrained far longer than allocators anticipate, freezing distributions across early-stage institutional portfolios. As trapped managers exhaust their reserves, private equity secondaries and corporate carve-out buyers will find an expanding supply of distressed technology assets sold by funds forced to liquidate before full term. Capital will continue to concentrate into a small cluster of top-decile franchises, starving mid-tier funds of institutional re-commitments.