Last year, Luxembourg-based secondary direct specialist Cipio Partners produced figures suggesting that the average holding period for VC-backed companies doubled between 2002 and 2012, from 3.2 years to 6.4 years (an issue that was clearly exacerbated by the financial crisis). This was making it increasingly difficult for the typical 10-year venture fund to get in and out of companies – and the result has been that even after one or two (or even six) fund extensions, even the better firms still find themselves sitting on unsold assets.
As more funds approach the end of their lives, these single-asset deals represent a growing opportunity for secondaries players, says Diana Meyel, a partner at Cipio. “In today’s environment, people think of secondary directs in terms of portfolio transactions, maybe linked to zombie funds. But actually the situation has changed dramatically; that end of the market has become highly intermediated and very competitive. If we look at dealflow in our latest cycle, maybe half of it has come from single asset deals.”
Zombie firms with a portfolio of decent assets that they’re not incentivised to manage usually prefer to sell all their positions at once, she says – but firms who end up with a few tail-end assets are increasingly looking to sell their individual positions to their co-investors on that particular deal. This has manifest advantages. “There’s hardly any diligence because the co-investors know the asset and understand the risk, so they can move fast. That’s much easier than doing a whole portfolio transaction.” In fact, she believes, this market for tail-end assets could be even more active – if LPs start to force the issue a bit more.
Another opportunity for secondary direct players arises from national governments’ efforts to plug the funding gap for early-stage or seed phase companies via state-backed funds. The trouble is, says Meyel, most are limited in what they can do with later-stage companies.
“There’s usually a maximum amount they can invest in any single company, and they’re not meant to provide finance to companies that can get it on the open market. And now the average time to exit is increasing, it’s harder for them to participate all the way through to the final round of financing; if the company gets to a D or E round, and there are ‘pay-to-play’ terms, they could even find themselves being effectively wiped out and losing their initial investment. So these agencies have a strong interest in new members joining the syndicate who can take over their stake, pay them a profit and then continue financing the company.”
Buying out inactive founders is another good source of deals, according to Meyel (as happened with Cipio’s recent investment in eyeware retailer MyOptique). So too is investing in mature tech companies who are the wrong profile for VC firms but too small for the buyout groups, she adds.
So what’s in it for these companies to have Cipio (or other firms like it) on the register? “The most important value we can add is to provide fresh capital. The second is to get the right management team. Third, we can help with corporate finance issues. And fourth, we can help with business development by using our network to make introductions.”
And, importantly, it avoids a full-blown fundraising process. “In today’s market, external fundraising eats up a lot of management time and resource – it can take 6-9 months to close a round. And you don’t really want to be shopping the business around or talking about valuations publicly. So the existing syndicate approaches someone like us who can buy the shares and at the same time participate in a [fresh] financing round.”