Continuation Funds and Secondaries: New Strategies in Venture Capital
Continuation funds are gaining traction in venture capital (VC) as firms look for innovative ways to navigate market downturns and liquidity challenges. Initially prevalent in private equity, these funds are now being adopted by leading VC firms like Lightspeed Venture Partners and NEA. Their growing popularity is due to their success in managing assets and providing liquidity, with a median return of 1.4x on invested capital, compared to 1.2x for buyout funds, Pitchbook reports.
-> Adoption in Venture Capital
VC firms are turning to continuation funds to retain high-potential assets longer, especially when traditional exit routes like IPOs and M&As are less accessible. Firms such as RockPort Capital, Lightspeed, and Shasta Ventures are using these funds to implement new asset management strategies. Continuation funds enable these firms to extend the investment horizon for their portfolio companies, potentially leading to higher valuations and improved returns.
-> Challenges and Opportunities
Despite their advantages, continuation funds face challenges, including regulatory concerns and fair asset valuation. Effectively managing conflicts of interest and offering attractive terms to investors are critical for these funds' success. As market conditions evolve, the success of continuation funds will depend significantly on the resurgence of IPOs and M&A activities.
-> Secondary Buyers and Co-Investments
According to an article by Axios, secondary buyers are increasingly using co-investments and other strategies to expand their equity stakes in continuation funds and strengthen their negotiating position. In 2023, secondary funds raised $78.3 billion, the second-highest total in a decade (see graph). Sovereign wealth funds and insurance companies have shown strong interest in co-investing, indicating a growing trend in the market.
Traditionally, secondary funds limited their exposure to single companies to 1-2.5% of their total commitments. However, there is now a trend towards increasing these limits to handle larger deals. By partnering with co-investors, secondary buyers can make higher bids, reduce the need for large syndicates, and compete more effectively for substantial transactions.
The future of continuation funds in the VC sector looks promising as firms seek new strategies to manage market challenges and improve asset management. The growing use of co-investments by secondary buyers highlights the evolving landscape. As market dynamics shift, the success of these funds will depend on their ability to navigate regulatory requirements, manage conflicts of interest, and offer competitive terms to investors. The revival of IPOs and M&A opportunities will also be crucial in shaping the future of continuation funds and secondaries in venture capital.
- Lightspeed Venture Partners is refocusing on the secondary market and is applying to become a "registered investment adviser" to invest more than 20% of its funds in this area. This shift comes amid a challenging environment for venture capital, with significant declines in fundraising and start-up valuations. Over the past three years, Lightspeed has invested $580 million in secondary shares and has established a data platform to identify these opportunities. Despite this new focus, Lightspeed remains dedicated to supporting its current portfolio. Similar strategies are being adopted by other venture capital firms like Andreessen Horowitz and Sequoia Capital in response to market changes.
- Fort Washington Capital Partners Group, a Cincinnati-based GP-led and special situations-focused manager, is aiming to raise $400 million for its largest secondaries vehicle to date, the Fort Washington Opportunities Fund - Secondaries. According to the MWRA Employees' Retirement System, the firm had raised at least $95 million by mid-May and anticipates a final close in March next year.
- Savano Capital Partners, a venture and direct secondaries firm based in Baltimore, aims to raise its largest fund to date. The firm is seeking $250 million for Savano Capital Partners IV, a VC secondaries fund, as reported by the MWRA Employees' Retirement System. Although the launch date is unclear, the firm filed a Form D with the US Securities and Exchange Commission on May 22. By mid-May, it was uncertain how much capital had been raised. Fund IV’s target significantly surpasses the $157 million raised for Fund III, which closed in 2022 after launching in 2020 with a $150 million target.
- Investment firms are raising billions to buy stakes in VC-backed tech startups, driven by the lack of IPOs and mergers. This has created significant opportunities in the secondary market, where investors and employees trade shares in private companies. For example, Lexington Partners launched a $23 billion fund to purchase stakes from large investors, surpassing their initial $15 billion goal due to high demand. This market growth has benefited startup employees and distressed limited partners needing to reduce their venture exposure. Last year, U.S. venture capital fundraising fell to a six-year low of $67 billion, prompting discussions about the evolving investment landscape and the changing profile of startup founders.
- Hamilton Lane has closed its sixth secondaries fund, securing $5.6 billion in commitments from a diverse range of investors including corporate and public pension funds, Taft-Hartley plans, sovereign wealth funds, endowments, foundations, and private wealth platforms. Fund VI surpassed its $5 billion target and exceeded the $3.9 billion raised by its 2021 predecessor. As of March 31, 2024, Hamilton Lane’s secondaries platform manages approximately $20.9 billion in assets. The firm maintains offices across North America, Europe, Asia Pacific, and the Middle East.
- StepStone has successfully closed its StepStone VC Secondaries Fund VI at $3.3 billion, surpassing its predecessor's $2.6 billion. This fund, which attracted strong interest from existing and new investors, represents the largest-ever fund dedicated to venture secondaries. It highlights a growing investor appetite for mature startup investments that offer reduced risk and quicker returns amidst a challenging primary venture capital market. This underscores LPs' ongoing commitment to venture capital, prioritizing strategies that provide liquidity and stability amid market fluctuations.
- ADIA subsidiary leads $120m investment in beauty platform Purplle. ADIA’s leadership in the recent funding round for Purplle Group underscores the attractiveness of the Indian retail market. The $120m raised in this Series E round involved both primary and secondary share issuances. Primary shares introduce new capital directly into the company, while secondary shares involve the transfer of existing shares between investors. This blend indicates a robust interest from both new and existing shareholders. Notably, initial investors like Goldman Sachs and Verlinvest have partially sold their stakes, making room for new investors, including prominent Indian family offices. Purplle, which became a unicorn in June 2022 following a $33m investment led by South Korea’s Paramark Ventures and existing supporters Blume Ventures and Premji Invest, continues to capture significant investor interest.
If you’d like to discuss any secondary market opportunities, feel free to contact me at tbarnes@axisgroupventures.com.
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