Why more and more VCs are turning to the secondary market

Why more and more VCs are turning to the secondary market

Sitting atop mountains of dry powder, venture capitalists have no shortage of capital to pour into large, late-stage rounds. Consequently, this enables mature companies to stay private—and lock up value—longer. (Unicorns alone account for about $877 billion in illiquid value right now.)

Under rising pressure to distribute returns, VCs with aging portfolio companies are exploring alternative ways to achieve liquidity for their LPs. One alternative is secondary transactions, which give investors the opportunity to realize value and return capital without a full exit.

Despite secondaries still being clouded by a lingering “distressed seller” stigma, rapid growth in the market indicates that VC-backed companies and investors are increasingly recognizing the benefits.
 

In January, early Uber investors achieved partial liquidity thanks to a secondary deal led by SoftBank Group. The exiting investors, including Benchmark Capital, First Round Capital, Menlo Ventures and former CEO Travis Kalanick, sold a portion of their equity for an estimated $8 billion. Benchmark Capital, which invested in the company’s Series A, B and C, sold 1.95 percent of its 13 percent stake.
 

Secondaries can smooth the transition from private to public

Secondary transactions can also help mitigate potential volatility when a company is first publicly listed. Shareholders who need liquidity get the opportunity to sell beforehand, which limits an early trading frenzy. Plus, a secondary sale can help gauge investor sentiment—essentially providing a sneak peek at the demand for a company’s shares—and determine a more accurate price.

In fact, Spotify investors completed several secondary transactions leading up to the company’s direct listing in April. The deals provided an opportunity for price discovery and eliminated “pent-up” liquidity needs, smoothing the unicorn’s transition to the public market.
 

Secondary market likely to grow with demand for liquidity

The average time for VC-backed companies to exit continues to extend—and the secondary market will likely grow in parallel to the demand for liquidity. Also, more investors will probably follow in the wake of Uber and Spotify, whose deals put a spotlight on secondaries.

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