The worst M&A and IPO environment in over a decade is forcing many VC firms to consider selling their startup stakes to secondary buyers in order to return capital to LPs.
While VCs are exploring all flavors of secondary solutions, continuation funds are gaining more momentum than other transaction types, investors say. These vehicles allow existing LPs to sell aging assets to new buyers or roll those investments into the new fund.
“All of a sudden, everybody across the board is asking about [continuation funds]. Everybody’s saying, ‘How do you do this,’” said Joe Binder, a partner at law firm Debevoise & Plimpton.
But despite the massive increase in interest, hardly any VCs or crossover funds are ready to pull the trigger on such transactions. That may change as assets are marked down further.
Similar to other exit opportunities, whether M&A or IPOs, the large valuation disconnect between what new investors are willing to pay and what existing investors think the assets are worth is preventing these deals from happening.
Secondary buyers are asking for a much higher discount than most VCs can stomach. Investors don’t expect many more of these deals to start taking place until there’s a reset in valuations.
Despite the large price disconnect, at least one continuation fund managed to close last year. Insight Partners set up a $1.3 billion second continuation fund in May. Existing LPs were allowed to sell their stakes to secondhand buyers HarbourVest Partners and Lexington Partners or transfer their position to the new vehicle.
One big problem is that different funds are carrying the same companies at dramatically different valuations.
“There’s probably bigger dispersion in holding values of late-stage venture assets than there’s ever been in the history of venture,” said Ken Sawyer, managing director at Saints Capital, a secondaries VC firm.
While many funds have already marked down their book values, Sawyer and others expect that another round of markdowns will take place as auditors review VCs’ 2023 financials. Once the asset values are reduced further, VCs may feel more comfortable selling at the discounted prices.
Secondary funds are gaining popularity because they provide options for LPs in an environment where startups stay private longer and a wave of meaningful exits may still be some time away. Limited partners that need cash can sell, while others can opt to stay invested.
Some LPs point out that continuation funds often include VCs’ best assets and that selling them in the current environment may mean leaving money on the table.
“Do you sell something that still has considerable upside?” said Chris Douvos, a managing director at Ahoy Capital, which invests in funds and startups. “Do you take a quarter of liquidity today or a $1 tomorrow? That’s the challenge.”
LPs’ decision to back a continuation vehicle or sell their position hinges on their liquidity needs and outlook for the assets in question.
But for now, because of price disconnect, few LPs are being offered the choice. The discussions about continuation vehicles are still at the GP level. Kirsten Morin, co-head of venture capital at HighVista Strategies, an asset manager that invests in venture funds, said she is still not hearing much about potential continuation funds.
However, Binder expects that some continuation vehicles will eventually close.
“The volume of private companies is so vast, and the number of private managers is so great, there will still be interest and transactions in the secondary space,” he said.
Featured image by Arctic-Images/Getty Images
Learn more about our editorial standards.
