One thing that stands out from these reports is the volume represented by venture-capital (VC) secondaries. Although VC accounts for more than 15% of all PE fundraising over the past 20 years, VC secondaries make up just 3–5% of the overall market. That’s all the more striking given the slower return of capital from VC funds and the fact that the average lifetime of a VC fund tends to be around 15 years.
What makes VC secondaries particularly interesting is the variance of the fund year in which a portfolio company can find its product-market fit – and achieves that ‘hockey-stick’ growth. And the year in question (the seventh year of the fund, say ) may not have a bearing on how large the outcome can be. So from a VC investor’s perspective, there’s usually an urge to hang on a little longer – an instinct that often proves correct.
In the current market, this hold period has been exacerbated by three macro factors:
In 2021 and 2022, the VC/growth market probably saw the best liquidity cycle in the last decade. Whether liquidity gets better or worse from here I will leave to the reader’s judgement.
The last few years have seen participation in the VC market from floating/opportunistic investors, with a notable set of retail investors among them. The patience of these investors is about to be tested.
Idiosyncratic events, the likes of which we have been witnessing in the last few weeks (SVB, Signature, Credit Suisse) bring with them volatility and dampen the exit environment.
And so it’s likely that the hold period for VC funds is about to get longer, which means that there will be increasing opportunity to buy out existing investors that are tired or want to de-risk/ cash-out. Apart from the standard assessment of the companies and their metrics, here are the topics I would focus on to value a secondary portfolio:
- Fund’s valuation policy – Last-round pricing (most common today) or the option-pricing model. This could be a double-edged sword.
- The liquidation stack – Where the portfolio companies sit in their respective liquidation stack and the nature and scale of the preference higher up.
- Unfunded allocation – The fund’s ability to maintain its pro rata share in the companies (where needed) – the unfunded available and its allocation. This ties into the cash runway for the underlying companies.
Co-investor consortium – An intangible in many ways. Basically, assessing the quality of the other investors in the portfolio companies.
You may ask why venture secondaries lag behind those for buyout. One reason could be that most of the PE secondary behemoths of today were founded by buyout veterans and so, I suspect, there was always an inclination towards that sub-section of the broader asset class. But that is changing, and I believe that we are likely to see venture secondaries proliferate in the next few years.
Stay tuned for more insights and updates on venture secondaries in the coming weeks!