Venture with caution

The VC secondaries market is booming but buyers should beware entering a booming market at a time of sweeping change.

All investments are tech investments, as the saying goes, and never has it been truer than in the past 18 months. The pandemic accelerated cross-market trends in health-tech, ed-tech, e-commerce and many other markets, prompting limited partners to whip out their chequebooks.

A total of 19 venture funds raised $1 billion or more in closings through the end of September, according to affiliate title Venture Capital Journal data, accounting for more than 57 percent of the fundraising value during the period. Through the first nine months of the year, venture funds raised $96 billion, already surpassing the overall 2020 total of $85.8 billion.

This is trickling down to the secondaries market. There was $46 billion of secondaries transaction volume in the first half of this year, with venture capital and growth accounting for 23 percent, or $10.6 billion, according to investment bank Greenhill’s mid-year report. This compares with 19 percent, or $11.4 billion, for full-year 2020.

This data does not include the world of direct venture secondaries, which while difficult to put a figure on, could be even larger than the LP interest market, according to Hans Swildens, founder of VC secondaries firm Industry Ventures. Venture-backed assets are staying private for longer and coming to look more like growth equity assets. As one of the few liquidity options for shareholders in these businesses, the direct secondaries market will only grow.

While the fundamentals all point to a very strong future for the VC secondaries market, a word of caution is required.

In the short-term, institutional LPs are bumping up against the limits of their allocations to the asset class. Since start-ups have been raising at higher valuations, these assets are growing faster than other investment buckets, Chris Douvos, founder of early-stage VC firm Ahoy Capital, told PitchBook.

VC investing involves a specific set of skills at the best of times: “Venture is difficult for folks to understand in aggregate. The companies are not cashflowing, so you can’t do a financial analysis,” Swildens told Secondaries Investor back in 2017. Venture-backed companies, particularly those considered “covid-resistant”, are demanding eye-popping price tags.

With interest rates potentially on the rise and the 12-year run of easy debt slipping slowly away, buyers will need to be sure they have a clear view when they reach into the dark matter of the sellers’ market in venture secondaries.

How has your appetite for VC secondaries changed since the pandemic? Email the author