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Secondaries

VCs sacrifice future gains for cash amid IPO dry spell

Some investors are selling stakes in their best companies at significant discounts

The lowest venture capital fund distribution environment since the global financial crisis is driving some investors to knowingly leave money on the table.

To return cash to their LPs, these early-stage VCs are selling secondary stakes in their best portfolio companies to later-stage investors at significant discounts. The tactic is an about-face for an industry that preaches patience in the face of market swings. It shows how the multiyear drought of IPOs and M&A is forcing the hands of venture firms.

“A lot of the primary deals that we’re doing now have big secondary components,” said Miguel Luiña, managing director for fund investments at Hamilton Lane.

It’s not uncommon for early investors to sell some of their shares to incoming investors when a portfolio company raises a fresh round.

What’s different now is that the sellers are parting with all or a large fraction of their stakes in strong startups at prices that are as much as 60% lower than the new round’s headline valuation, according to Luiña. The secondary buyers are paying a different price than other new investors for the same shares, essentially lowering the blended price of the latest round.

For example, Luiña said Hamilton Lane currently is a co-investor in a high-growth, cash-flow-positive company that’s in the process of raising new capital in conjunction with a large secondary round.

“This company wants to raise a very small primary round not because it needs capital, but to show that it has stepped up in valuation from [a few years ago],” he said. Luiña declined to identify the company.

This kind of deal exemplifies changed attitudes in early-stage VCs toward cashing out sooner.

Christopher McKinnon, a partner at law firm Morrison Foerster, has also noticed that VCs are accepting a larger discount for secondaries than they historically would.

“I see VC funds that got in early try take some of the risk off the table [because] they want to chalk up actual realized [returns] at 2x, 3x or 5x,” he said. “Even if they think [it’ll get] 25x if they continue to hold.”

In the peak of the last bull run, there was an expectation that an exit at an even higher valuation would be just around the corner. A company’s existing VCs with foresight to take chips off the table before the market soured succeeded in selling early-stage stakes to growth investors at minimal or no discounts to the new primary round price.

YL Ventures, a Silicon Valley- and Tel Aviv-based cybersecurity-focused firm, sold its entire stake in Axonius to Series D investors in 2021 at no discount, according to managing partner Yoav Leitersdorf. That year, YL also offloaded most of its stake in Orca Security in conjunction with the company’s Series C fundraiseat the same price as the primary round, Leitersdorf said.

Many investors now regret not locking in their gains several years ago, said Luiña. He added that VCs are not trying to maximize “every last dollar” but are instead trying to find a balance between returning cash to LPs and long-term returns.

But eager sellers are finding that there aren’t many growth-stage secondary buyers, according to Devon Kirk, co-head at Portage Capital Solutions, where she works on structured equity deals.

“If you need cash, you may just [have] to accept a larger discount than you would otherwise,” she said.

Featured image by John M Lund Photography Inc/Getty Images

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