Secondaries have been around for a long time — but we’ve recently seen the market take off.
“In the last couple of years, we saw a secondary component to almost every mid to late stage fundraise,” says Mike Turner, London partner at law firm Latham & Watkins, adding that more recently, the financing form has even snuck its way into the negotiations of early-stage startups and VCs in search of some liquidity.
Some VC firms have committed to the trend: In April, Isomer Capital launched a £100m fund dedicated to buying stakes in other VC firms from LPs, and earlier this year London-based investment firm Launchbay Capital closed $25m of a targeted $100m fund to buy secondaries from VCs looking for exits out of startups.
So, what’s driving the secondaries wave, and how is it impacting the VC-backed scene?
A buzz in the market
Europe often looks to the US as an ecosystem example, says Turner — and across the pond, secondaries are in the midst of a moment.
“Lately it has appeared to us as though almost every late-stage tech company is either doing one or talking about doing one in the US, and so I suspect that a lot of that will spill over into Europe as well,” says Michael Podolny, a Latham & Watkins partner based in San Francisco. “I would say that we are probably experiencing the peak in the number of secondaries that we're seeing in the tech industry ever.”
Lately it has appeared to us as though almost every late-stage tech company is either doing one or talking about doing one in the US.
Isomer Capital invests in secondaries from its fund of funds and a dedicated secondaries fund.
“As a buyer we are interested in secondaries because they offer our investors exposure to European venture-backed technology assets with a shorter time horizon and a lower risk profile, while at the same time providing much-needed liquidity to our VC and founder partners, as well as the wider market,” says Joe Schorge, Isomer Capital’s managing partner.
“Early-stage funds have been facing an increasing need and requirement to create some liquidity for their LPs [and] to help raise the next funds,” says Turner. “Whenever there is a secondary opportunity in their investee companies, we're seeing those earlier seed and pre seed investors increasingly selling down — their need for liquidity has absolutely driven their behaviour, no question about it.”
Recent evolutions
While secondaries have often been reserved for late-stage companies trying to free up cash for employees or VCs selling up while waiting for a delayed IPO, the financing form is making its way into the earlier stages of the ecosystem.
According to London-based Latham & Watkins partner Shing Lo, secondaries are an attractive option for companies building in in-demand sectors, like AI.
“For a hot AI company looking to raise money, there could be multiple investors willing to invest, but there is insufficient headroom to accommodate additional primary because the company does not need the additional capital for its stage. So, what it may do is allow the founders to sell down some shares, which allows them to do a small secondary whilst accommodating additional investors,” she says.
The type of banks that you would be hiring to do your IPO are now interested in assisting with this transaction earlier in the company’s life cycle, partly to see if there’s an interest, if there are investors, what the price is and so on.
And as secondaries become more common at earlier stages, investor attitudes are also changing. Investors are much more tolerant of that happening, whereas a few years ago, even a year ago, they probably would not have liked founders taking money off the table [before] Series A,” says Turner.
Alongside the increase in popularity across Europe, Turner also highlights that the type of secondaries the firm are seeing have started to change.
“We're seeing a lot of well-structured employee secondaries,” he says. “Where companies have realised that their ability to give liquidity to employees has probably been pushed out a few years, because their exit plans have been delayed.”
And it’s not just VC firms wanting a piece of the pie. Over in the US, investment banks are also getting involved in secondary transactions. “They are assisting companies in finding investors to buy directly from employees and other shareholders of the company in secondaries,” says Podolny.
At later stages, this could be down to banks testing out the market for an IPO. “The type of banks that you would be hiring to do your IPO are now interested in assisting with this transaction earlier in the company’s life cycle, partly to see if there’s an interest, if there are investors, what the price is and so on — it's the same group of investors that may be interested in later on doing an IPO,” Podolny adds.
Europe is also starting to see investment banks get involved, says Lo — along with a third player on the scene: “In more complex secondaries with numerous employees in multiple jurisdictions, the paying agent (who would normally be involved in an M&A transaction) could be engaged to handle distribution of proceeds to employees.”
The wait for IPO
Executing a secondary deal is no mean feat — and as the companies involved become increasingly global, the complications grow.
“There is no universal regime for these types of transactions and they are complicated, certainly on the legal front,” says Podolny.
We have a lot of pre-IPO mandates now, and that means that we need to do secondaries for all sorts of reasons.
Schorge agrees, adding that “the most complicated aspect of engaging in secondaries for a VC fund is sourcing opportunities: transactions are private, off-market, confidential and require trusted relationships and access to data”.
“Additionally, pricing these less mature and less visible assets in the venture market is challenging, as it involves getting access to data and a more qualitative analysis and negotiation compared to the more straightforward — often intermediated — processes in private equity,” he adds.
As more companies wait for favourable IPO conditions and VCs itch to get liquidity back to LPs, Turner predicts that secondaries are only going to grow in popularity in the next year.
“We have a lot of pre-IPO mandates now, and that means that we need to do secondaries for all sorts of reasons,” he says. “This ranges from cleaning up the cap table, to bringing in new investors to help provide strategic value pre- IPO or in the IPO, to giving the employees some liquidity to take some cash off the table in the run up to the IPO.”
Lo adds that she expects there to be more secondaries in the future.
"[We] are getting more instructions on secondaries," she says. "I think it goes to show the trend is here to stay and there's going to be more to come."
