Secondaries Remain in Wonderland

If the IPO market would provide the volume of exits it did a decade or two ago, venture fund investors would not be so eager to sell stakes on the secondary market.

But since it isn’t, and older venture funds are facing the end of their planned lifespans with sizeable portfolios of companies still awaiting exits, secondary dealmaking is still going strong.

That was a takeaway from yesterday’s IBF Venture Secondary Investing Conference in San Francisco. I popped in for a couple of panels and chatted with some of the buyers, sellers and intermediaries who congregated at the Bently Reserve conference center in the financial district’s Le Meridien Hotel. Oddly, it was the second time I’d been there in as many days. Just the night before, by unintentional irony, the center had been bedecked in Alice in Wonderland-themed splendor for venture firm Canaan Partner’s Web 2.0 After Dark Party.

By sunset, flower displays, oversized mushrooms and champagne flutes were put away. Secondary conference attendees arrived to find bags printed with the logo of Sherwood Partners, a provider of “managed wind-downs” for the kinds of venture-backed companies that no longer get invited to Web 2.0 parties.

I caught up with Sherwood co-managing member Martin Pichinson (whose last quote I used was prefaced by the phrase “bah humbug”) in the lobby, where he informed me that, contrary to reports, the U.S. economy is not recovering. Nor, he predicts, will it recover next year, or any year, until the nation’s masses of unemployed get back to work and the U.S. regains much of manufacturing foothold it’s ceded to China in the past couple decades.

As for venture, times are still tough. Larry Allen managing member of NYPPEX, a secondary market maker, told me he expects wind-downs of venture capital funds to increase over the next year. Partly, that’s simple timing, as more dot-com bubble-era funds hit the end of their planned lifecycle. Partly, it’s pressure from limited partners, as well, says Allen, as more LPs press general partners to terminate funds rather than continue the managing them for more years in hopes of exits down the road.

There are also more lender-forced sales going on than people realize, Allen says. These are cases in which banks have either loaned money to venture-backed companies directly, loaned money to companies with some sort of VC guarantee, or simply extended credit directly to venture funds for providing additional rounds or continuing to pay their people.

Oh, and venture funds are still overstating their value, Allen says. His view is that venture funds stated net asset values are overvalued by approximately 32% as of June 30th. As a result, funds that sell in the secondary market often look like they’re selling for big discounts, but their value may simply have been marked up.

But not all the news was downbeat. Secondary purchases of shares from founders, early employees and angels are becoming more prevalent, enabling those groups to get some partial liquidity. And with valuations in certain hot sectors on the rise, early entrants are seeing some nice returns without having to even wait for a full exit.

Gady Nemirovsky, general partner at Inspiration Ventures, for instance, says he’s made a practice of selling part of the fund’s stakes in portfolio companies during subsequent financing rounds. So far, the approach has worked out well, enabling Inspiration in cases to recoup its initial investment while still maintaining a stake. But the practice only works, he says, if Inspiration is willing to sell stakes in any company it initially backs. If the fund cherry-picks only certain companies to sell, it could signal to investors on follow-on rounds that Inspiration is less keen.

“You need to be careful, because that’s a big red flag,”  Nemirovsky says. “Our philosophy is if we think it’s the next Google, then we’re still selling… Despite the fact that you believe every deal you do is going to be the next Facebook, it doesn’t work out like that.”