Secondary Funds Raise Billions As VCs, LPs Seek Liquidity Exit Options

As IPOs and M&A options remain relatively moribund compared to expectations or desires, venture investors are increasingly turning to secondary funds as a means of securing at least some sort of exit that offers liquidity. 

Secondary funds have raised billions in the past two years as investors seek alternatives and as other investors see a means of generating returns while also potentially cashing in once public markets and acquisitions become more expansive. VC's need to get at least some money back so they can invest in the next round of opportunities and secondary funds appear to be that vehicle. JL

Marc Vartabedian reports in the Wall Street Journal:

Venture investors and limited partners eager to cash out of venture positions are turning to secondary funds, which acquire startup stakes from venture funds and LP stakes in funds. Venture investors committed large amounts of capital to startups during 2021, but initial public offerings and mergers-and-acquisitions, the primary ways venture firms cash out investments and return capital to LPs, slowed starting in 2022. That left venture firms and LPs hungry for alternative liquidity options. Secondary venture funds collectively raised roughly $100 million in the first quarter of this year, after raising $3 billion in 2022 and $1.6 billion last year.

Scarce liquidity options for investors in the venture ecosystem propelled StepStone Group’s $3.3 billion capital raise for a new secondary venture fund unveiled last week, blowing past the amount raised last year for all such funds.

The New York-based private markets investment firm is seeing increased demand for its venture-capital secondary services as more institutions and wealthy individuals backing venture funds seek payouts amid a paltry exit environment. Venture investors and limited partners eager to cash out of venture positions are turning to secondary funds, which acquire startup stakes from venture funds and LP stakes in funds. 

“LPs are saying, ‘You haven’t sent us any money back in a few years,’” StepStone Partner Brian Borton said. “We’re set up to be that liquidity provider.” 

Limited partners don’t always have a detailed view of all the startups their fund investments back, creating an opportunity for StepStone to spot deals where fund stakes might be worth more than what LPs think, Borton said. 

“This creates a tremendous arbitrage opportunity for us to capitalize on,” Borton said. The firm has bought stakes over the past year at 50% to 100% discounts, he added, noting 90% of gains within its secondary venture fund portfolio come from valuation growth as opposed to discounted entry.

 

Purchasing startup stakes of funds accounts for roughly two-thirds of StepStone’s secondary venture business, while buying LP stakes makes up a third, Borton said.  

StepStone’s previous secondary venture fund was a $2.6 billion vehicle raised in 2022. The firm launched its first such fund in 2014 and said strong performance in the venture industry over the last decade combined with limited liquidity opportunities in recent years has boosted its business and helped it raise larger funds.  

Venture investors committed large amounts of capital to startups during 2021, but initial public offerings and mergers-and-acquisitions, the primary ways venture firms cash out investments and return capital to LPs, slowed starting in 2022. That left venture firms and LPs hungry for alternative liquidity options.

“Liquidity issues for the early-stage investors is really driving the secondaries right now,” said Kyle Stanford, the lead U.S. venture capital research analyst at research firm PitchBook.

Secondary venture funds collectively raised roughly $100 million in the first quarter of this year, after raising $3 billion in 2022 and $1.6 billion last year, according to PitchBook.

“LPs need to get some money back to rebalance their portfolios,” Stanford said. “Now there’s a reason for someone like StepStone to raise $3.3 billion to invest solely in secondaries.” 

Borton said he is aware of other funds trying to enter the sector, but noted that operating in the secondary market niche comes with challenges. Firms typically aim to offload their losers, Borton said, leaving StepStone with the tricky and risky job of identifying bets the firms are wrong about in their assumptions.