Are secondaries becoming second nature?

The rise of secondaries in Europe

In light of the declining number of exits in Europe during the last 24 months, venture capital (VC) funds are increasingly turning to the secondary market to generate a return for their limited partners (LPs). Whilst secondaries were previously reserved for later stage businesses, market conditions and trends have caused the secondaries market to open to businesses at an earlier stage and increasingly to follow a US trend of VC fund ‘strip sales’. 

The reasons

The recent boom in secondary transactions is driven by three key factors:

1. The wait for an exit

The past 24 months have seen a decreasing number of exits as well as subdued IPO markets. The extension of timelines for a potential exit has caused VCs to turn to secondaries as a means of returning liquidity to LPs, with ‘strip sale’ secondaries becoming a broadly accepted portfolio management tool. Equally, for founders, secondaries are becoming a tool to manage incentivisation and reward pre-exit growth.

Returning liquidity is not the only reason for the uptick. As companies and VCs wait for a turn in the IPO markets, secondaries are being used as a means to prepare for a, hopefully, smooth IPO process further down the line; whether that be by using secondaries to tidy-up the cap table, or to bring in new investors with past IPO experience to add strategic knowledge.

2. Trending 'high demand' sectors

As well as being a method for VCs and early investors to see returns in later stage companies prior to a traditional exit, secondaries have also started making appearances in earlier stage ‘high demand’ companies. Recent popularity in certain new technologies, such as AI and increasingly defencetech, has led to instances of oversubscription and insufficient headroom to cope with demand. Historically investors have been uncomfortable with founders selling down their holdings early in the growth process (or employees participating in liquidity events prior to exit), however we are now seeing investors becoming more flexible in order to accommodate an increased investor base and acknowledge the extended exit timetable. This is giving founders and employees an opportunity to see liquidity much earlier in the company lifecycle than has been the case in the past, albeit tempered with the inevitable founder/employee incentivisation conundrum which is a tricky balance for all to strike. 

Secondaries have also started making appearances in earlier stage ‘high demand’ companies.

3. Dedicated secondary funds

In recent years, certain VC funds have leant into the increased trend in secondaries by launching dedicated secondary funds. Over the last 12 months, there have been a number of high profile dedicated funds launched. How these funds are utilising capital is mixed, for some the target is specific VC-backed businesses turning profitable, while for others it is ‘strip sale’ portfolio acquisitions.

On the portfolio acquisition side, a good example is Molten’s 2024 acquisition of a significant majority stake in Connect Ventures’ first fund via a ‘strip sale’ transaction for around £18.6m. Molten have described this as part of a specific strategy to acquire LP positions in funds made up of later stage portfolios with strong potential for near-term realisation. 

The targets share a common maturity profile aligned with the exit scarcity.

With an extended wait for IPO and/or full exit opportunities likely to remain prevalent, the secondaries trend is set to continue.

The future

With an extended wait for IPO and/or full exit opportunities likely to remain prevalent, the secondaries trend is set to continue. A recent survey suggested nearly 80% of tech founders are very likely or somewhat likely to execute a secondary in the next 12 months, and the quantum of funds being raised targeting strip sale secondaries continues to grow. Additionally, whilst the fintech space has been the sector pioneering the increase in secondaries, secondary focused funds are predicting that this trend will start to see an increase in the B2B SaaS, green energy, healthcare and AI sectors.

Finally, one unknown is how the UK’s PISCES framework, an innovative new type of market for private companies designed to facilitate secondary liquidity through a structured platform, will impact the secondary market and whether its public exchange approach (whilst avoiding full public market requirements) will impact how secondary transactions (particularly those targeting specific businesses with large numbers of minority shareholders / employee shareholders) are executed. It will be interesting to monitor its progress over the next 12-18 months.