VC Secondaries: Types, Trends, and a Comparison to PE Secondaries

In recent years, secondary transactions have emerged as a prevalent solution for providing liquidity to Limited Partners (LPs) in the private investment funds industry. While the term "secondaries" has historically encompassed a broad spectrum of transactions across various asset classes and investment strategies, a closer examination reveals distinct differences in deal structures, vernacular, and execution within specific segments of the private investment funds industry. This article focuses on delineating the nuances of secondaries transactions within the venture capital (VC) sector and draws comparisons with traditional private equity (PE) secondaries.

Deal Pricing: VC vs. PE

A fundamental distinction between VC and PE secondaries lies in the pricing models. PE secondaries typically rely on the net asset value (NAV) of a portfolio of interests in private companies. In contrast, VC deals often tie the book value of a fund's underlying portfolio companies to their previous financing rounds, resulting in a potential disconnect between book value and NAV. This discrepancy poses challenges in marking-to-market portfolios of LP interests in VC, as the book value may not accurately reflect a company's current financial condition.

Transfer Restrictions: Navigating Obstacles

Transfer restrictions play a crucial role in both VC and PE investments. However, VC agreements typically impose more stringent limitations on the transfer of ownership. Venture-backed companies, including unicorns, design their agreements to make transfers challenging, adding complexity to VC secondaries. In contrast, PE investment agreements commonly include broader exemptions and carveouts, facilitating secondary transactions.

Direct Secondaries: A VC-Specific Solution

Unlike PE, VC often sees "direct secondaries" where buyers acquire interests directly from shareholders of portfolio companies, bypassing LP interests. This approach provides liquidity for shareholders and enables VC investors to increase exposure to specific companies, a less practical option in PE where portfolio companies are typically majority-owned by the selling firm.

Portfolio Company Tenders: VC's Unique Approach

VC secondaries introduce the concept of "Portfolio Company Tender Offers," allowing third-party institutional buyers to purchase interests directly from existing shareholders, including employees. This approach, uncommon in traditional PE, enables successful unicorns to facilitate liquidity without diluting founders and early institutional investors.

Portfolio Sales: An Efficient VC Exit

"Portfolio Sales" in VC borrow concepts from PE secondaries but differ in execution. These transactions involve selling an entire portfolio of investments, providing an efficient exit option for VC sponsors to liquidate a fund's holdings. Careful consideration is needed, as these sales may not resemble traditional venture M&A-style exits.

Sales of Limited Partner Interests: Pricing Challenges

The VC pricing methodology presents obstacles when marketing limited partner interests. In various economic conditions, the perceived value of VC fund portfolios may fluctuate, making it challenging for limited partners to sell large portfolios purely in VC funds. Institutional limited partners often manage their exposure to VC through bundled trades that include other fund positions.

Conclusion

In conclusion, VC secondaries present a unique set of challenges and opportunities distinct from traditional PE secondaries. Navigating deal pricing, transfer restrictions, regulatory implications, tax considerations, and the variety of transaction types requires a nuanced understanding of the intricacies within the venture capital segment of the private investment funds industry. As the landscape continues to evolve, stakeholders must adapt to the dynamic nature of VC secondaries to capitalize on emerging trends and ensure successful transactions.