Dany Bidar
Principal – Secondaries Fund Manager at Octopus Ventures
From cars to sneakers, wherever there’s a primary market, chances are a secondary one underlies it. In the consumer space, limited edition trainers boast incredible resale value, while motorists are more likely to opt for a used car than a new one. And with climate concerns building the momentum behind a shift towards a more ‘circular economy’, secondary markets are growing even more.
Secondary markets (Secondaries) are just as present in the investment world. Investors enjoy easy access to the Secondary market, trading in and out of their positions in highly liquid and transparent public markets like NASDAQ or the New York Stock Exchange, but things are trickier with asset classes such as Private Equity (PE) and Venture Capital (VC).
These are both inherently illiquid, with investors’ capital typically locked in for a decade or more – but as the PE and VC markets expand, and liquidity needs grow, the role of Secondaries within the two asset classes has become increasingly important.
While the PE Secondaries market is now well-established, we think VC Secondaries represent an incredible opportunity not just for investors — but for business founders and management teams too. Let’s start by taking a look at PE Secondaries, to see what lessons it might hold for the VC market.
The PE Secondaries market as proof of concept
Today, the PE Secondaries market is a standalone, differentiated asset class, with over $100bn in volumes — but it wasn’t always so1. Historically, the PE Secondaries market was characterised by distressed sales. The technology crash of 2000 and the Global Financial Crisis of 2008 both triggered an upswing in Secondaries volumes, as stakeholders scrambled for liquidity amidst economic turbulence. With governments cracking down with stringent new capital requirements in the wake of the Global Financial Crisis, banks and insurance companies were forced to sell illiquid PE assets to meet them, and sales continued.
As the dust settled, ultra-low interest rates drove the expansion of the primary PE market, as investors turned to riskier, but higher yielding, assets — and the PE Secondaries market’s development continued. For Limited Partners (LPs), it became an attractive portfolio management tool, enabling them to lock in realised gains, or rebalance fund exposures, through an early exit. It also became handy for General Partners (GPs), who could use the PE Secondaries market to secure additional capital and buy time to maximise the value of their unrealised portfolios.
Where it had historically been driven by market volatility and distress, the PE Secondaries market became invaluable to investors struggling with PE’s closed-ended investment structure. With capital typically locked away for 10 years or more, the PE Secondaries market offers a mechanism to free it up.
As a result, the PE Secondaries market has grown from annual volumes of around $2bn2 in the early noughties, to the established asset class, with over $100bn in volumes, that we see today.
So what does this mean for VC Secondaries?
The same closed-ended investment structure and post-2008 macro-economic conditions, described above, have also impacted the VC market. A similar influx of capital has seen it expand — and Venture Capital LPs and GPs have the same liquidity needs as their counterparts in PE.
That already makes the VC Secondaries market attractive, but we think it could be an even more compelling opportunity still.
One of the characteristics of the tech companies that have risen to prominence over the past twenty-odd years is that they are staying private for longer. The median timeline to IPO has increased from around five years, in 1999, to about 11 years by 20213. Because of the post-2008 abundance of capital, VC-backed tech businesses have been able to raise more funding rounds — at a larger scale. This has reduced the level of exit activity relative to the rate of capital deployment from GPs, and so the pressure on GPs to return capital to their LPs has mounted. This pressure isn’t only coming from LPs. Founders, employees and early-stage investors are also looking for liquidity, while management teams are increasingly using it as a retention tool. The VC Secondaries market provides a way to relieve this pressure.
The US is the world’s most mature Venture Capital market and holds clues about what’s to come for Europe. Since 2006, fundraising volumes in the US have increased from around $30bn to over $128bn in 20214. There’s been a corresponding growth in deal volumes, from $30bn in 2006 to $167bn in 2020 — which doubled in a year, to $330bn in 20214. As a result, the number of Unicorns has grown over 16x in five years, from 21 in 2016 to 340 in 20215. Clearly, the primary market is growing at a rapid pace. And as I’ve written, where there’s a primary market — there’s an underlying secondary one.
Carta is a widely used cap table management platform in the US, which private tech companies are increasingly turning to for completion of their Secondaries liquidity programmes. It has experienced an increase in transaction volumes from around $400m in 2019 to around $7.4bn in 20216. This 330% compound annual growth rate (CAGR) significantly outstrips the CAGRs of both US primary VC deal volumes and VC fundraising over the same period. It’s also worth highlighting that the Carta volumes only represent a small portion of the global VC Direct Secondaries market; in 2021, it was estimated at around $60bn7. It’s expected to triple by 2025.
What does this mean for European VC Secondaries?
Between 2017 and 2021, capital invested in European tech increased from around $20bn to over $120bn8. More than 300 unicorns8 have grown out from startup hubs in at least 65 cities9 — with 98 emerging last year alone8. It took two decades for the European tech ecosystem to reach $1trn in December 2018. Since then, it has trebled to $3trn8. It’s fair to say that Europe is creating value from the tech ecosystem faster than ever.
The primary VC market in Europe is catching up with the US10. European startups now enjoy almost the same proportion of early-stage funding as their American counterparts. US VC funds are taking notice: many have set up shop on this side of the Atlantic in a bid to capture a piece of the pie. As the US example illustrates, growth in the primary market has significant, positive repercussions for Secondaries.
To provide some context, certain market commentators have claimed that at any given time, around 10% of VC market participants are looking for liquidity11. If this is true, it suggests that the European VC Secondaries market has grown from around $2bn in 2017 to $12bn in 2021. This paints a compelling picture of what’s on the horizon for the European VC Secondaries market — especially in light of the primary market’s unprecedented growth.
Conclusion
As we’ve seen, the history of the PE Secondaries market points to the incredible opportunity in the VC space. The US offers a guide to how things stand to unfold — but it’s already happening.
With its rapid growth rate, we at Octopus Ventures believe that the European VC Secondaries market represents an incredible opportunity for investors, founders and management teams alike.
Nothing in Venture Capital is ever fully de-risked, but for LPs, VC Secondaries offer a less risky point of access to European Tech as an asset class, relative to traditional venture investing.
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1 Once “Unloved,” Private Equity Secondaries Just Had a Record Year | Institutional Investor
2 Introductory Guide to Investing in Private Equity Secondaries
3 Initial Public Offerings: Median Age of IPOs Through 2021
4 Six charts that show 2021’s record year for US venture capital | PitchBook
5 The meteoric rise of US unicorns in 2021 | PitchBook
6 The 2021 Carta liquidity report
7 The Rise of the Venture Secondary Market | Greenspring Associates
9 Tech investors can’t get enough of Europe’s fizzing startup scene | The Economist
10 How does Europe’s VC scene compare to that in the US? | Sifted
11 Secondary VC Investing: The Next Best Thing | Jumpstart
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