More than two and a half years after resigning from the venture firm he founded, Dave McClure is back with Practical Venture Capital, which is raising a secondaries fund.
“We’re definitely going to launch a secondary fund for venture capital,” says McClure, founder of seed investor 500 Startups. He is joined in the effort by general partner Aman Verjee, former chief operating officer of 500 Startups, and Stephanie Shorter, who was hired in January to run investor relations.
The timing of the fund seems inopportune, given the economic turmoil caused by the novel coronavirus. In fact, a number of venture and private equity funds expect fundraising to be particularly difficult.
But McClure is undeterred. “I agree [that it’s more difficult] for general VC fundraising, but not for this strategy,” McClure tells Venture Capital Journal. “I would say secondaries strategies are in vogue right now because they are something that actually does better in downturns, not worse.”
McClure declined to say how much the firm plans to raise, but a source familiar with the effort says the goal is to raise “a $100 million-plus fund.”
While it works on fundraising, PVC will pursue a strategy similar to a fundless sponsor, raising one or more special purpose vehicles for one-off deals. It registered its first SPV, Practical VC – Flash 1A LP, with the SEC on March 11. The filing does not show a targeted amount. Investors in the SPVs will likely be high-net-worth individuals and family offices. PVC will tap institutional investors for the larger fund, the source says.
McClure says his firm will purchase stakes in micro VC funds, in particular funds smaller than $50 million and five to 10 years of age. “For the most part, we will be buying LP and GP interests, but we might be buying some directs as well,” he says.
The firm plans to make about 10 transactions, ranging in size from $5 million to $25 million each, the source says.
McClure expects to find plenty of opportunities. He estimates there are about 600 micro VC funds (under $100 million each) in the US and about 300 internationally. “We’re probably looking at the top third of that, so a universe of about 100 to 200 funds,” he says. “There’s way more inventory out there than we could possibly conceive of buying.”
McClure believes his strategy is unique. “Nobody is really buying fund positions that early,” he says. “We think the market is mispricing risk and missing out on growth. If you’re able to buy earlier in the cycle you can capture more of that growth.”
Simply put, “our thesis is about skipping the J curve,” he says. That means PVC will focus on buying assets that are about five years post-seed.
It is a risky strategy. Investors are essentially betting a company as young as 5 years old will grow into a successful enterprise and ultimately get sold or go public.
PVC expects to mitigate a good chunk of risk by getting a steep discount on net asset values (NAV), anywhere from 25 percent to 50 percent. Last year, the average discount to NAV for VC stakes was about 23 percent, greater than the 17 percent the prior year, according to investment bank Greenhill & Co. To put that into perspective, the average discount to NAV for buyout stakes was about 7 percent in 2019, larger than the 3 percent the prior year, Greenhill reports.
In addition to steep discounts, McClure is banking on his 25-plus years of experience with start-ups and venture capital to help him pick winners. His resume includes launching and running his own start-up for more than five years before selling it, running marketing for PayPal for three years, angel investing for four years, investing for Founders Fund for about a year and a half, and founding and investing for 500 Startups for more than seven years.
During his time at 500 Startups, the seed investor backed more than 2,500 companies, of which 17 are unicorns and four went public, he says. Big hits include Twilio (NYSE: TWLO), which has a market cap of $10 billion, and Credit Karma, which agreed to sell out Intuit for $7.1 billion in February.
McClure left 500 Startups after he was accused of inappropriate behavior toward women. In a blog post from July 2017, he writes, “I made advances towards multiple women in work-related situations, where it was clearly inappropriate… My behavior was inexcusable and wrong.”
McClure declined to talk about what he has been up to since departing 500 Startups, other than working on PVC. He also declined to comment on whether concerns about his past behavior might hurt his fundraising efforts.
The secondary market has been growing like a weed for the past three years, surging from $58 billion in 2017 to $88 billion last year, according to Greenhill, which published the Global Secondary Market Trends & Outlook in January.
Most of the volume in VC secondaries is in what’s called direct secondaries, in which individual shareholders (such as general partners) sell shares in privately held companies. Industry Ventures, which specializes in buying secondary venture assets, says direct secondaries account for about three-fourths of the venture secondaries market. The remainder is largely made of LPs that sell fund stakes.
PVC’s focus jibes with increased interest by GPs in selling stakes over the past several years. Greenhill notes “GPs [have] increasingly utilized the secondary market as a proactive fund management tool.” GP-led secondaries accounted for $26 billion of transaction volume last year, or about 30 percent of the total, Greenhill says.
PVC appears to have a unique strategy, but it is one of several firms with an appetite for venture LP stakes and GPs’ own fund commitments. The most well-known firms in that market are Greenspring Associates, Industry Ventures and Lexington Partners. All of them target bigger, later-stage deals than PVC.
Another player is Isomer Capital, which will look at new-vintage, very small investments in Europe. Generally, investing in small VC deals doesn’t make sense for most secondary firms given the return they require to move the needle.
Beyond specialists, such secondary groups as Goldman Sachs Asset Management and Coller Capital dabble in VC secondaries. The market segment is generally seen as risky by mainstream PE secondaries buyers, who say it requires a lot of tech know how and good relationships.
Hans Swildens, founder of Industry Ventures, told VCJ sister publication Secondaries Investor in 2018: “Just coming in to the market and buying venture capital at a discount doesn’t work a lot of the time, because 80 percent of the companies in these funds don’t make money. If someone doesn’t know what they’re doing, they come in to the market, buy a load of stuff and after three or four years they realize they are losing money all over the place.”
Limited partners in VC secondaries funds tend to be family offices, high-net-worth individuals or VC partners and founders investing on an individual basis. Industry Ventures and Greenspring are unusual in that they have been able to attract institutional capital.
Additional reporting by Rod James of Secondaries Investor.