Secondaries: Reshaping the Exit Landscape for VC funds

Secondaries: Reshaping the Exit Landscape for VC funds

The VC landscape is always evolving. One of the most significant shifts we've seen recently over the last few years is the rise of VC secondaries. Traditionally, venture capital has been a game of patience, with investors waiting for an IPO or M&A events to see returns. But now, secondaries are reshaping the exit landscape and providing VC funds with new pathways to liquidity.

What exactly Is a VC Secondary?

A VC secondary transaction is a sale of shares from an existing investor to a new one. Unlike primary investments, where fresh capital is injected directly into a startup, secondaries involve a change of hands for already issued shares. This shift can happen at multiple levels, from investors or employees’ stake to entire fund positions. In essence, secondaries provide a way to exit without an actual IPO or M&A event, and for many, that flexibility is a game-changer.

Why is the Secondaries Market Booming?

Although secondaries have been common in other asset classes like real assets or private equity, over the last few years they have become much more popular in venture capital. This is due to the convergence of several factors:

1. Extended Timelines to IPO:
   Startups are staying private much longer, and the era of quick IPOs is over. This is evident when we look at the founding dates of the major IPO candidates for 2025: Canva (2012), Stripe (2010), Figma (2012), and Klarna (2005).
2. Slowdown in M&A Activity:
   As a result of the zero interest rate policy, after COVID, we saw M&A transaction activity reach unprecedented levels. However, just three years later, we faced a very different scenario, with the highest inflation and interest rates in the past 20 years. Consequently, the M&A market collapsed. Despite some reactivation in 2024, activity remains below pre-COVID levels.
3. Increased Pressure from LPs:
   In a context with limited liquidity options, fund managers are facing additional pressure from LPs, who have seen cash distributions decline significantly.

Investors in alternative assets have not been unaware of this context and have rushed to raise funds specialized in secondary transactions, providing liquidity to the VC ecosystem in exchange for investing at attractive valuations.

How can secondary deals be structured?

There are different types of secondary transactions depending on the underlying asset:

• LP-led secondaries refer to the sale of a Limited Partner's (LP) stake in an investment fund to another LP. These transactions may require varying degrees of participation and approval from the fund's General Partners (GPs).
• GP-led secondaries refer to a General Partner's (GP) sale of stakes in portfolio companies. These can be structured in several ways:
  
  • Direct secondaries: The simplest scenario, where the GP sells its stake in one or more companies to another investor.
  • Strip sales: In this scenario, a portion (“strip”) of the portfolio is sold by the GP to another investor.
  • Continuation funds: A GP creates a new vehicle to hold one or more portfolio companies beyond the life of the original fund, attracting fresh capital to extend the holding period.
  • Preferred equity deals: The GP sells its stake in one or more companies while maintaining exposure to the company's upside once the secondary investor achieves a certain level of return.‍

Secondaries: the new normal

The rise of secondaries is not just a trend; it's a reflection of a more mature and dynamic VC ecosystem. In a market where companies are opting to stay private longer, secondaries offer a crucial release valve for liquidity. For GPs, this presents both an opportunity and a challenge—an opportunity to deliver returns without waiting for traditional exits and a challenge to develop the skills and relationships needed to navigate a more complex market.

As we move forward, it's clear that secondaries will play a pivotal role in shaping the future of venture capital. GPs who embrace this trend and master the necessary capabilities will be the ones leading the next era of VC success.

In this context, those GPs who develop the right skillset for secondary transactions will have a competitive advantage over those who continue playing the wait-and-see-until-IPO game.

Secondaries require a specific toolkit

1. Active portfolio management: Understanding the optimal timing to engage in a secondary transaction is crucial. GPs need to accurately assess a company’s trajectory and align valuation expectations between sellers and buyers. Overestimating the potential of an asset or waiting too long can diminish returns.
2. Deal Structuring Expertise: From continuation funds to preferred equity deals, secondaries structures are getting more complex and substantially differ from the typical VC investments and exits.‍

Foster the right relationships: Secondary investments involve a broader and distinct set of stakeholders compared to traditional venture capital investments. Building these relationships is crucial.