The venture capital (“VC”) market has evolved and grown substantially over the past decade. Until recently largely viewed as a more nascent private markets asset class, VC is starting to reach maturation, with secondaries transactions being a strong driving force.
While no longer a niche category, VC secondaries represent an area in which few investors have expertise or strong track records, and one that has typically thrived during times of uncertainty and volatility. This combination of an underserved space with favorable market conditions is generating strong interest from investors, who have become increasingly aware of the opportunity to diversify their portfolios and access venture returns with a shorter holding period, quicker drawdowns, a mitigated J-curve, and vintage-year diversification. Due to these characteristics, secondaries are more palatable in general for more risk-averse investors, as well as those who may not have much VC expertise but wish to add the asset class to their portfolios.
Join us in exploring this growing sector of the venture capital market in a series that will unpack:
- The venture secondaries transaction universe and considerations for investing in the growing opportunity set;
- Fundamental drivers of the secondary market growth, particularly the emergence of GP-led restructurings as a viable liquidity tool for General Partners and Limited Partners, alike;
- Investment implications for institutional portfolios and the role venture secondaries can play in the context of a broader private equity allocation.
Part II: Secondary Market Growth Drivers: Are They Here to Stay?
What is driving the mammoth increase of opportunity in this evolving secondary VC market? The answer is that there are a number of tailwinds and fundamental drivers within the venture secondary ecosystem that contribute to the increasing rise in opportunity.
1. Companies Are Staying Private Longer
The average time to liquidity (from initial funding to IPO) has increased from three years in 2000 to eight years in 2020. Companies are staying private for longer and building to larger scale, size and value which is captured privately and remaining unrealized in portfolios longer. Growth and maturation in the venture asset class has also resulted in more private capital to support large, late-stage and secondary transactions rounds.
Source: Average Time from Initial Equity Funding to IPO: ThomsonOne.
2. The Rise of “Private IPOs”
The last decade has seen a large increase in private IPOs, with the number of pre-IPO large-scale financing rounds ($100+ million) increasing nine times from ~25 in 2010 to around 225 in 2020. Simultaneously, a tremendous amount of capital is now available for later and growth stage companies. This further perpetuates time to liquidity extensions in the market.
Source: The Rise of Private IPOs: Q3 2020 Pitchbook NVCA Venture Monitor.
3. Higher Valuations
With companies staying private and locking up more value for longer, private companies are capturing a disproportionate share of market value. Currently, the average of the top 25 private US VC-backed companies is in excess of $15 billion. The increased time to liquidity and higher valuations ultimately culminate in early stakeholders, founders, and employees seeking liquidity options well before the ultimate exit event. In instances such as these, secondary purchasers can be valuable service providers to key stakeholders seeking liquidity while continuing to build and grow their companies pre-exit.
4. Extended Fund Life
GPs can choose to extend their Funds’ life as result of the increased unrealized value in their portfolios. The data suggests that this is only becoming more prevalent, with the proportion of funds whose life is 13 years (73%) far outweighing those with a life of 10-13 years, extending well beyond the typical 8-10 year mark for original fund term plus extensions. Venture LPs are therefore increasingly interested in generating cash-on-cash returns with an increasingly illiquid asset, an outcome made possible through secondary sale transactions. These transactions also serve to provide investors with flexibility and means for exit outside of the traditional IPO or M&A route, whereby they may take liquidity and even reinvest a portion of their proceeds back into the venture market.
With these dynamics at play, the universe of secondary transactions, whether direct secondaries, LP interest or GP restructuring, will continue to grow. Moreover, transactions of each type are winning propositions for General Partners, Limited Partners and the venture asset class as a whole, only serving to reinforce the growth in the secondaries market and making it an increasingly important avenue for accessing the innovation economy.
 US Private Equity/Venture Capital Fund Life: InstitutionalInvestor.com, “The New Reality of the 14-Year Venture Capital Fund.”
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