Peak XV cuts vintage India funds in overheated market. Will catch up with profit later.

Peak XV Partners, formerly a part of US venture capital firm Sequoia Capital, has reduced its $2.85 billion India and Southeast Asia fund by $465 million, signaling a cautious investment stance on its growth bets. 

It has also changed its fee-carry structure, bringing its share of profits down to the traditional 2:20 model, from the 2.5:30 Sequoia Capital model, although Peak’s share of profits will increase once it returns a pre-agreed sum back to its investors. A 2:20 fee-carry structure indicates a management fee of 2% of the corpus raised and a 20% share of the profit.

“We are investing in a measured manner in our growth fund, while we continue to lean in on seed and venture stage opportunities. As a result, we have made the decision to re-size our 2022 vintage funds by 16%,” Peak XV said in a statement on Wednesday.

The bulk of the reduction will happen on Peak XV’s growth bets, where the firm sees fewer bets and an overvalued market. With this, Peak XV will have a little over $1.7 billion earmarked for growth investments from its 2022 fund, and about $630 million for seed and venture-stage investments.

Since 2022, Peak XV has deployed a third of its growth capital. 

The decision comes as the broader startup ecosystem in India faces a dearth of high-quality investment opportunities, particularly from companies that raised capital at inflated valuations during the pandemic, when funding was more abundant.

“It is a seller’s market. It cannot be both a buyer’s and a seller’s market” said a person familiar with Peak XV’s strategy, pointing out that Peak XV has taken advantage of the liquidity available by selling $1-1.2 billion of its investments over the past year, including through block trades involving the stocks of Zomato, Mamaearth, Indigo Paints, GoColours and recently Cloudnine Hospitals.

This also comes at a time when other venture capital firms are raising much larger funds. Lightspeed is raising $7 billion across three funds globally, The Information reported on Tuesday. 

Also read | Temasek set to buy Peak XV’s 20% stake in Cloudnine

Partner economics 

For Peak XV Partners, the move indicates an immediate cut in management fee—which is now down to a 2% of the corpus raised, similar to what investors pay most other private fund managers. 

In addition to the fund reduction, Peak XV will tie part of its carried interest to the distribution of profits in its growth and multi-stage funds. The firm noted that seed and venture fund economics would remain unchanged.

In a letter to its investors, known as limited partners, Peak XV revealed it is lowering its management fees to 2% on three growth and four multi-stage funds, a Bloomberg report said, citing the letter. 

This is a retrospective move to reduce carry on funds raised 10 years ago. 

Also read | Peak XV, Google, Hillhouse eye part exits as CarDekho plans IPO

Peak XV is also reducing its carried interest—its share of the profits—to 20%, though its “catch-up” will still be around 30%. 

A catch-up phase refers to the share in profit that firms can command once they have returned the fund corpus to their investors and a pre-agreed multiple on the principal. In the catch-up phase, the returns on the exit will go to Peak XV first till it hits up to (in this case) 30% in share of profits. 

Investment managers with smaller funds are able to hit the catch-up stage faster because they are able to return the capital to their investors and reach their milestones earlier, which allows for a higher chance of boosting their internal rate of return.   

A reduced fee gives a fund a lot more capital to invest and more room to underwrite deals in a highly competitive growth-capital market, the person cited above added.

If Peak XV was splitting a deal with another VC earlier, the other VC’s investors would get a higher return on the same deal because of the way the investment was structured. 

Also read | Indian companies junk private deals, take the IPO route for higher valuations

Focus on exits 

The reconfiguration follows last year’s major restructuring, when Sequoia Capital split into three independent entities to focus on the US, China, and India-Southeast Asia markets. Sequoia India and Southeast Asia, which had raised $9.2 billion across 13 funds, was rebranded as Peak XV after the transition. 

However, to truly shed the Sequoia Capital tag, Peak XV would need to rapidly finish deploying and returning its funds soon. By the end of the year, it expects to surpass its previous best exit years, the person cited above added. 

While this is first time Peak XV is downsizing its fund, its former global parent last year pared the size of two major venture funds, including its cryptocurrency fund, as part of a dramatic broader startup downturn, the Wall Street Journal reported in July 2023. 

According to a second person aware of Peak XV's plans, with the rebranding, the Indian franchise no longer has to pay royalty to Sequoia Capital, and hence the realignment of the fee structure will not cause a bigger dent.

These changes further underline the difficult cuts venture capital firms had to undertake as they try to undo the explosive expansion and liberal spending that characterized a historic startup boom a few years earlier.

According to a limited partner who spoke on condition of anonymity, Peak XV's decision to trim its fund size will impact fundraising for other firms. 

"Other GPs will now be wary of upsizing their funds," he said. GPs, or general partners, are fund managers who select companies to invest in and manage the fund's portfolio.

Also read | Accel eyes partial exits from multiple early investments