For the past couple of years, investors have been telling startup founders to get their houses in order.
Venture capitalists want their portfolio companies to become financially sustainable after a series of interest rate hikes by central bankers brought the frothy pandemic era — defined by cheap capital — to an end.
Now, those very investors have been forced to look a little closer to home. Venture capitalists need to free up cash and return money to their own investors, known as limited partners (LPs).
Typically, this is achieved by exits where a company they’ve invested in goes public or is bought up by another business. But the European exit market is in a very difficult spot.
As a result, investors are now faced with doubling down on their portfolio companies — many of whom touting inflated valuations — or cutting their losses and selling their shares on the secondary markets.
“There’s definitely been a rush to create what’s happened in Silicon Valley,” said Michael Smith, a partner at US impact fund Regeneration VC, referring to the uptick in secondary share sales in Europe.
The secondary share sales market in the US is well established. San Francisco-based Industry Ventures, which was founded 23 years ago and manages $7 billion in institutional capital, has long dominated the space there. But the market in Europe is much more nascent.
Most VC funds agree to return their profits to their LPs within 10 years. But for those reaching the end of those investment terms now, the timing couldn’t be worse.
“Venture funds are coming to their end of life and need to get liquidity for their underlying LPs,” said Regeneration’s Smith, who is based in Amsterdam.
“The discounts those funds are taking are having huge impacts on valuations — that liquidity back is either helping or harming additional LP commitments or investments made from those funds.”
The idea is that LPs will continue to back them if they free up much-needed liquidity, but they could end up exiting a company at a lower price than they paid to get in.
“Europe’s first” venture secondary fund was launched by London-based Balderton Capital in 2018, which has also sold secondhand shares. A record 31 secondary funds headquartered in Europe were established in 2021, amid the hype period, with $29 billion in assets under management per PitchBook. Another 24 were created in 2022, the second-busiest year for the bloc, and raised a cumulative $21.5 billion.
There are plenty of sellers, too: European funds Cherry Ventures, Speedinvest, Index Ventures, and Albion VC are among those that exited companies via secondary transactions in 2023, according to PitchBook.
Recent sales have seen stock sold for an average haircut of 50% on their most recent funding validation, Kelly Rodriques, the CEO of secondary marketplace Forge Global, told the Financial Times. The platform also saw a 50% increase in trading from Q3 2022 to Q3 2023.
An absence of buyers
The jury is still out on whether this is a long-term trend for European VC.
One sticking point is a lack of obvious buyers, according to Hussein Kanji, partner at European firm Hoxton Ventures. Many incumbent secondary shops are private equity plays and are not known for placing risky bets on early-stage tech companies, Kanji told Business Insider.
“They’re not tech literate in the way you need to be, because you’re not just taking the price risk of today, you’re also taking the risk on the market in the future and the technology stacks,” he said.
“What if AI comes in and disrupts one of these companies? How do you figure out how to price that into how you’re buying the shares?”
It all comes down to how buoyant the VC market is: “If the market is good again, then who’s going to sell secondary? Because then you go back to ‘I’ll buy and I’ll just hold until the IPO’,” Kanji added.
Some companies – notably Stripe and Space X, per the newsletter Newcomer – are using secondary sales to their advantage to buy back their own shares.
And it’s not all bad: secondary sales can provide early-stage investors with an exit before founders are ready to sell or IPO, according to Tom Henriksson, partner at deep tech fund OpenOcean.
“You can still, as an early-stage investor, actually get out at least partly and make a profitable investment during the journey,” he said.
OpeanOcean sold shares of Sequoia-backed caller ID company True Caller three times over the years but still retained a stake. It first invested in True Caller in 2012; it’s now public.
“And they were all very profitable sales,” Henrikkson added.
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