The secondaries industry has been growing like a weed for the past few years, but the growth has largely been driven by the sale of private equity portfolios by LPs and single-asset deals led by PE firms. Venture capital secondaries currently account for less than 20 percent of LP- and GP-led deals.
But we have seen a recent surge in fundraising by firms focused on VC secondaries. Managers in the market include longtime VC specialist Industry Ventures, which is targeting about $1.5 billion for its latest vehicle; brand new firm Pinegrove Capital Partners (a joint effort by Brookfield Asset Management and Sequoia Heritage), which is seeking $2 billion; and StepStone Group, which is reportedly targeting more than $2.6 billion for its StepStone VC Secondaries Fund VI.
What’s driving the sudden interest in venture secondaries? Here are some key reasons cited by GPs and LPs at a recent event focused on “the future of venture secondaries,” which was produced by NewView Capital. The firm, which does growth investing and venture secondaries, allowed Venture Capital Journal to watch recordings of the event.
Potential for big returns
“I think with venture secondaries, what comes to mind is larger discounts and the potential for higher returns,” said a person who focuses on secondaries and liquidity solutions at a large institutional investor. “That obviously makes things a lot more interesting for us. Furthermore, I’d say there’s less competition. There is lower competition in secondaries overall, but even less so in the venture space. Unless you have the right information and tools for a particular transaction, you’re not going to come to the table.”
Jefferies’ H1 2023 Global Secondary Market Review noted a stark difference in pricing for VC funds compared to buyout funds. Buyout portfolios sold for about 90 percent of NAV in the first half of this year, while venture portfolios went for about 69 percent of NAV in that same period, Jefferies reported.
Savvy buyers can generate nice returns, judging by the performance of Industry Ventures’ funds. Affiliate title Secondaries Investor reported last week that Industry was among the top performers in its analysis of secondaries funds that closed in or before 2019 for which performance data was available. The VC secondaries specialist generated an average IRR of 27 percent across 14 funds that closed in or before 2019, Secondaries Investor reported. Industry ranked second behind StepStone Group, which produced an average IRR of 29.5 percent across six secondaries funds, including three focused on VC and growth equity, according to Secondaries Investor.
Hot companies at a discount
If you can’t get into a primary round for a hot private tech company, the secondary market is a way to get in through the back door and possibly at a discount. For example, VC-backed payments company Stripe sold about $6.5 billion-worth of employee shares in March in a deal that valued it at about $50 billion, significantly less than its $95 billion valuation in March 2021.
“We’d love to make a bunch of direct investments, but we also recognize the valuation environment and that primary capital fundraises may not [happen] in the near term,” said a person who manages VC investments on behalf of a large pension system. “So, we are actively thinking about secondaries as a way to potentially access those companies that we want to invest in and potentially as a way to solve for a bit of a valuation correction.”
The person noted that because of the way the secondary market works, the LP doesn’t have to rush into deals if it isn’t comfortable with the pricing. “We’re very conscious of being patient and I think the dynamic of secondaries really allows you to be patient, because you can set your parameters and sit back and wait, which is great.”
Access to secular trends
A managing director at a global investment advisor said one of the big draws of VC secondaries is being able to participate in the upside of secular trends, such as the rise of cloud computing. Watching some of those trends play out, the advisor concluded, “If we weren’t investing in venture secondaries within our secondary platform we’re missing out on a pretty big opportunity,” the managing director said. He added that he believes traditional secondary funds that opted not to participate in the venture space likely “regret that today because it’s really driven some outsized returns.”
The secondaries expert at the large institutional investor agreed. “Venture is tied to the tech sector, and a lot of thematic growth comes from that sector,” the person said. “The business models that are coming out of there are far superior to the legacy business models and some of the other verticals, so it’s exciting to be betting behind that thematic growth over time.”
There are, of course, many more compelling reasons why LPs and GPs are surging into VC secondaries. We will continue to explore and expound on this topic, as we anticipate no shortage of venture secondaries news in the coming months. Stay tuned.
This story has been updated