Venture managers increasingly look to secondaries to deal with aging assets

Insight Venture Partners, a growth- and early-stage investor, has been working on a restructuring process to move assets out of older funds into a continuation vehicle that will give the GP more time to manage the assets.

Insight is one of a handful of top-line venture managers who have turned to the secondary market to sort out older funds.

As the secondary market breaks records for deal activity, it has drawn in more mainstream managers as a way to deliver liquidity to investors in older funds.

The stigma that once existed as part of secondary deals is gone. Where once secondary deals were viewed as the moves of distressed institutions, or signs of an underperforming fund, such processes are generally viewed today as portfolio management tools.

But secondary activity over the past few years has been confined mostly to the buyout and growth-equity sides of the private markets. Recently, venture managers have explored using the secondary market to sort out older funds.

Secondaries intermediary Greenhill Cogent found that venture funds were about 29 percent of secondary-market volume in 2018, up about 7 percentage points from 2017. Total volume came in around $74 billion last year, the firm said.

Greenhill Cogent said venture/growth represented 12 percent of total GP-led deals in the secondary market last year.

This increase was driven by “sellers looking to lock in returns and reduce exposure to certain venture managers that have generally been slower to distribute relative to their buyout-focused peers,” according to Greenhill Cogent’s 2018 year-end secondary-volume report.

“All of this is a byproduct of timed liquidity and extended hold periods these funds are having to go through even though there’s still a lot of value in the partnerships,” said David York, managing director of Top Tier Capital Partners.

While venture secondary volume has been creeping up in recent years, NEA’s large secondary-backed spinout last year may have opened the doors to more meaningful activity in the sector.

NEA completed a $1.35 billion spinout of assets from older funds into a new vehicle to be managed by a former NEA executive.

The new fund, NewView Capital, took in 31 assets from four older funds from 2006 to 2015. Goldman Sachs led a group that also included Hamilton Lane in buying the assets out of the older funds and kicking in fresh capital for add-on and new investments.

Other top-line firms along with Insight and NEA have been exploring secondaries as well. Technology Crossover Ventures completed a secondary deal last year. This year, Altos Ventures restructured its 2008 fund, moving assets into a continuation vehicle, in a deal led by Greenspring Associates.

Representatives from Insight Venture, TCV and Altos either declined to comment or didn’t respond to comment requests.

Market drivers

Motivations in the venture world have changed. The traditional exit path for a venture investment was an IPO or strategic acquirer. But these days private companies are choosing to stay private longer, which means longer hold periods, and potentially more capital requirements, for their venture owners.

The average time to liquidity in the venture world has been seven years during the two-year period ending Dec. 31, 2018, an April report from Greenspring shows. This is up significantly from the two-year period that ended Dec. 31, 2000, when the average time to liquidity was three years, the report said.

With exit paths narrowing, venture managers are sitting on aging portfolios with few options for existing investors.

“If you’re a venture manager who has been in business for decades, you can end up managing some pretty large portfolios,” said Joseph Marks, head of secondaries at Capital Dynamics, which includes venture as part of its secondaries focus. “These companies in general … need more time and attention.”

Secondaries managers are set to take advantage of the shifting dynamics. Secondaries funds are targeting at least $84.8 billion, according to Secondaries Investor data. At least 43 pools were in market across strategies including private equity, real estate, infrastructure and preferred equity, Secondaries Investor reported in Q1.

At least two firms, Lexington Partners and Ardian, are raising megafunds. Lexington is targeting $12 billion for its ninth fund, while Ardian is shooting for a total of $18 billion for its next secondaries program, which includes a commingled secondary fund and a co-investment pool.

However, not every traditional secondaries buyer targets venture capital. The dynamics are different from those in buyout funds, which target mature companies with more predictable cash flows and growth paths.

Venture assets are volatile and uncertain and can be tougher for buyers to model out, sources said. Venture companies usually have more cash needs than buyout companies because venture managers grow the businesses from early stages. And venture portfolios often include weak companies along with strong performers.

Also, many traditional secondary buyers have views into underlying assets in buyout portfolios through their primary exposure to funds, which is not necessarily the case on the venture side.

“There’ll be a lot more talk and exploration than there will be consummated deals,” Dan Burstein, co-founder of Millennium Technology Value Partners. He explained that on the venture side, pricing mismatches between buyers and sellers are still common.

“It’s not the kind of market that will suddenly have cascading tidal waves of volume,” Burstein said. “But there are going to be a handful of great opportunities coming down the pike … Anyone in the secondary business will buy a remnant portfolio if the price is right, but managers won’t be willing to part with great remnant portfolios at huge discounts.”

Overall activity

Venture is a small slice of total activity in the secondary market, which is busier than ever. The expectation is that barring some sort of economic collapse, deal volume is only going to increase, numerous secondary sources told Buyouts.

Traditional LP portfolio sales continue to lead market activity, but GP-led deals like restructurings are taking more market share. Last year, GP-led deals represented around 28 percent of total market volume, up from 24 percent in 2017, according to Evercore.

Two megadeals of roughly $5 billion each have roiled the market this year and potentially overturned expectations of the size of portfolios secondary buyers can take.

Japan’s Norinchukin Bank has been in the process of selling a portfolio of PE interests valued at around $5 billion. Ardian won a limited competitive process for the portfolio, Buyouts reported.

And Energy & Minerals Group has been working on a restructuring of its older funds, moving several large assets into a new fund that will enable the GP to manage the investments longer. The EMG deal could come in between $4 billion and $5 billion, though it will be challenging to complete, sources said.

The advent of the megadeal is a “game changer,” according to Mark Benedetti, co-head of Ardian USA. Benedetti declined comment on whether Ardian participated in the Norinchukin deal.

“A transaction of that size could open the eyes of some of their peers to say, ‘wow, if someone can get a $5 billion deal done, maybe I can do the same.’” Benedetti said.

Secondary intermediaries have traditionally felt the market could absorb only portfolios of $1.5 billion to $2 billion, but that mindset could change with the completion of a few large deals, Benedetti said.

Action Item: Check out Greenhill Cogent’s research here: https://www.greenhill.com/content/secondary-advisory