Startups

Venture funding has started flooding back in at least one area: Secondaries

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secondaries market illustrated with a red up arrow with two bandaids
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The venture secondaries market has been on the same roller-coaster ride as the broader VC market over the past few years, but it looks poised to break away in 2023.

Like venture capital as a whole, the secondaries market was hot in 2021 as a bunch of new players — sound familiar? — entered the space as crossover investors and traditional VCs forayed into buying secondary stakes as a way to get into hot deals they couldn’t access primary shares in. As the market turned in 2022, secondary deals quieted to the same volume as their venture counterparts amid mismatched valuations and expectations.

But while it’s unclear if the venture market has reached its bottom — some investors think it has, while others fear the worst is yet to come — secondary deals are breaking away. Data shows that transactions started to pick back up again in the second half of 2022, and multiple investors think 2023 could turn into a great year.

Javier Avalos, the co-founder and CEO of Caplight, a startup that tracks secondary activity, said that their data started to show the beginning of a turnaround in 2022. He said that the number of closed deals had been declining all year until it started to reverse in Q4. The number of bids — buyers offering what they’d pay to a company — also went up.

He added that the secondaries market was dealing with the same valuation issues in 2022 that were holding up many deals on the primary side: Investors and founders were valuing the same startup at vastly different prices. He said that once valuations started to compress and the range of prices at which people were willing to buy and sell narrowed, deals started to pick up.

“We have seen a lot of indicators recently that validate that the private secondary markets is back,” Avalos told TechCrunch. “Buyers are back in a way that they haven’t been in the last 12 months given the valuation correction.”

So, who exactly is selling?

John Avirett, a partner at StepStone Group, said that for most of 2022, the main sellers were limited partners looking to get liquidity from their long-term venture stakes because they were likely running into the denominator effect. But he thinks a lot more GPs will be looking to sell stakes in individual companies this year.

He added that because firms had been coming back into the market to raise funds much quicker over the last few years than in years prior, he thinks many will likely look to use secondary sales to beef up returns this year before heading back to their LPs to raise.

Christian Munafo, a portfolio manager at the Private Shares Fund, said that he anticipates — and has already noticed — that many of the crossover investors, including hedge funds, corporations and private equity investors, have started looking to dump shares.

“We understand their desire to seek alpha but that money tends to be pretty fluid,” Munafo said. “It comes in pretty fast [and] when they realize it isn’t working it tends to leave really fast. We are also seeing a lot of the corporate venture programs. It’s hard to watch because you’ve seen the movie before.”

Munafo said that the other major source of shares coming to market is through employee stock options. Companies have started staying private longer — and 2022 derailed an unknown number of startup exits — plus, the recent swath of startup layoffs means there are a lot of employee stock options set to expire.

“A lot of these people don’t have the liquidity to exercise them and take advantage of that opportunity and free up some net cash,” Munafo said.

But of course, for there to be a rise in closed deals, there have to be buyers. So while secondaries-focused investors like Avirett and Munafo have been seeking out opportunities, other firms are looking to snatch up these shares as well. Avalos said that Caplight has noticed a handful of venture capital and growth equity firms getting active again.

“They know the fundamental stories of the companies and know how these businesses are growing,” Avalos said. “They are saying the world is not falling apart. Not every private company is going to go to zero — they are fine. We are ready to invest at this lower valuation.”

He added that later-stage startups like Deel, Klarna and Stripe being more public about their lower valuations has also increased more secondary activity surrounding the companies. This bodes well for both secondaries and the venture market in general because it shows that once the valuations come back to earth, investors seem more than willing to put capital to work.

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