Liquidity Crunch Fuels $100Bn Secondary Market: Here's What You Need To Know

Sarah Chen-Spellings (Intro):

Exits, exits, exits. The question of liquidity has been top of mind for investors, LPs and GPs alike, as portfolios mature and the pressure of the next fund raise built. And yet with IPO and M&A markets not exactly heating up, many have turned to secondaries. But how should we really be thinking about them? How has the market for secondary transactions evolved in recent years? And importantly, how do we do it in a way that maximizes returns?

Martin Fleisher from Coller Capital and Ku Kay-Mok from Gobi Partners joined me in Helsinki earlier this summer to unpack all of it at the Arctic15 LP Investor Summit. You don't want to miss it.

Martin Fleischer:

Thank you, Sarah. Great to be here. Hi, everyone. Martin Fleischer from Collar Capital. For those guys who don't know Collar, we are a global secondaries firm. We have around $30 billion dollars of assets under management. We have a global platforms, some offices in London, New York, present on the West Coast.

I live in Copenhagen, Hong Kong, Seoul. So really a global reach. And all we do is secondaries private equity across asset classes. Right now we are investing out of our ninth fund, which has a 10 billion target on the private equity thing where we do growth, VC, and private equity. And then we have a secondaries credit fund that buys LP positions and does continuation vehicles and credit funds and does NAV loans.

We have a Chinese RMB fund that does secondaries in China. And then we're also moving into the private wealth channels with semi liquid structures and looking forward to discussing today this market is booming both from the GPs looking to drive exit themselves from GP continuation vehicles and a lot of institutions looking create liquidity in the absence of exits to LP sales.

Sarah Chen-Spellings:

Yeah, and we'll go a little bit into the framing of this landscape, how it's evolved over the years. Coller, of course, is a veteran in this space, and has seen the investment cycle, so we'll talk a little bit about that.

But we thought this would be useful to also have the GP perspective, that is looking for portfolio strategies as market continues to mature, as the portfolio continues to mature, and we have Ku Kay-Mok from Gobi.

Ku Kay-Mok:

Good morning everybody.

Quick spiel about Gobi. We're actually a Pan Asian fund, been around for 22 years. Currently we have 17 funds, total asset under management about $1.6 billion dollars. We're invested in 380 startups. And we actually have various funds that focus from seed stage to growth stage. So we span the whole spectrum.

A little bit about myself. I grew up in Singapore, went to college in Berkeley, did computer science. So I started off as a co-founder, as an entrepreneur in Silicon Valley during the dot com days. 2006, I moved back to Singapore, joined government venture fund.

I have been with Gobi since 2010, started their Southeast Asian operation. We have raised six funds in Southeast Asia, fully deployed. My focus nowadays is just focused on exit generation. That's what I'm here to talk about.

Sarah Chen-Spellings:

Thank you. And Martin, you are really the crystal ball for us here in some form. We've seen a lot of frankly, flat rounds, down rounds, startup valuations have declined and we are feeling the crunch on liquidity.

What are you seeing in the marketplace and what really is the secondaries opportunity? Is it just selling at a discount and this is not good news or how are you seeing that?

Martin Fleischer:

Look, the secondary market has grown tremendously, transaction volume is over 100 billion. I think when I started my career over 10 years ago, the market was around 13 billion and I think VC secondary is closing at $10 billion, right?

We are just seeing a lot of deal flow at the moment and a lot of it is really driven by liquidity. Number one, you had the denominator effect. You had a lot of pension funds that are waiting for distributions. They were all allocated to private markets. So they were using the secondary market to sell LP interest in both VC funds and private equity funds. A lot of motivated force sellers which drove a lot of discounts.

Then on the GP side, both for VC funds and on the private equity side, they sit on assets that are very good. But there's no exit at the horizon. And they have LPs who are asking for, when can we see some money back, we won't support you.

But on the other hand, they know if they're selling these assets in these markets, the best assets, they're not going to get the best prices. So what they're doing is really taking destiny in their own hands. Cherry picking the best assets and moving them into continuation vehicles, where they get an exit in the old fund and then they will continue to manage those assets in a new structure.

We are typically the main capital and we really function as the price setter, and coming with the bulk of the capital.

Sarah Chen-Spellings:

I know we've got a variety of LPs in the room. Some that are institutional, like EIF. Some that are family offices, and some that are new to venture, as a whole. And this is their first rodeo, frankly, right? As we heard from the family office panel, some of them are looking to increase their allocations from 10% to 20%, to 40%.

Share with us a little bit about what you mean here. How does the structure work? What are the economics here for LPs and GPs in the different examples that you gave?

Martin Fleischer:

If it's an LP led transaction, it's basically a clean break for the LP, so you have a family office or pension fund. They will basically sell an LP interest or portfolio of LP interest in buyout funds or VC funds.

And then we, they'll come to us and we will then give them a price for the overall portfolio. So let's say, we could buy 10 LP positions in 10 different venture funds that has 50 companies each. So we'll buy a diversified portfolio of 500 companies. That's good risk for us.

And that will come at a price at the moment. And while we saw during ‘21, pricing was close to NAV. What we really seen in the venture space is that discounts have been pretty steep.

If you look at the market reports, they have been between, 50% to a 30% discount for VC funds and growth funds. And the pricing is a little bit narrow in normal private equity, but the problem is you have a lot of intransparency in VC funds when basically we need to give a discount or a premium to the book value.

And what we see with some VC managers is they're still using old round valuations, so peak of the market. So obviously in order to determine fair value there's often a discount. And when we look at the continuation vehicles, that is the market that has grown the most in the secondary space. I think in 2016 that market was $10 billion. I think it's $60 billion now. It's the fastest growing markets in alternatives.

And it's really a no brainer for many GPs because they can get an exit in the old fund, but then they can keep holding on to the winning assets and get new fees and carry on those assets. So instead of giving the upside to someone else, they keep the upside. That's really driving this as an alternative exit route.

Especially as IPO markets are closed. What do you do if you had an asset for five or six years? Maybe you need more follow on capital. You can get that in a continuation fund. If you want to follow the other guys in the cap stack, we can help.

People just want to clean up their old funds. You have VC managers who weren't as a Series A investor, those companies are now mature software companies and they want to keep on riding the wave. But they still also need to return capital if the fund is over 10 years old.

Sarah Chen-Spellings:

Yeah, absolutely. And talking about pricing and finding the right place for both buyer and seller.

Mok, from a GP perspective, there are some GPs in the room that may be considering this option. How does this go wrong?

Ku Kay-Mok:

Yeah, I think, there are some challenges. But it could be unique to us because I do represent the sell side. I mean, Martin he probably sees deals across the spectrum. For us, the challenges that we face, number one is actually the cost of liquidity.

Because a lot of LPs in Asia, they're actually strategic LPs. So when we approach secondary sale, there is a discount. Unless they have financial reasons, whether it's portfolio rebalancing, they are trying to get liquidity re-up on GPs. A lot of times they just look at a discount and say, hey look, if this is such a discount for the corporation because they do make money from the core business.

For them, there's actually no incentive to liquidate with the discount. They rather hold. And then for some of our LPs which are, you know, government agencies, it's even worse, right? You know, we work for the government, you don't get rewarded for upside, but you get fired for downside. So you go to your boss and say, hey look, we have to sell at a discount, it’s a no go. So I think that's one of the challenges we see in pricing.

The other one that I think is more on the GP side, I've talked to Martin, keen to hear how they solve it, is actually among the GPs. At a point of a secondary, let's say a GP led transaction, there's usually a first generation partner and the next generation partners.

So there might be conflicts because of the carry split, because the first generation GPs is going to take the carry out. And for the continuation vehicles, the next generation partners, they will get the carry. So the valuation of the asset is critical. Because the first generation GP could feel, hey look, you undervalue my asset when you roll over.

So those are issues that we encounter.

Sarah Chen-Spellings:

Yeah, and Martin, to that, I mean, are you a bad news story as a whole? Or how do you make this transaction really a good news story in that it feels like a win-win?

Martin Fleischer:

I think we are the necessity in this market. I mean, a private market alternative is an illiquid asset class and closing fund structures are not always very efficient.

People want liquidity for various reasons, so what do you do? Look for pension funds, institutions who are LPs. We create a real exit route for the market will typically speak at pricing. There's other guys like us who will give a market price, but there is always a premium on liquidity.

It does depend how much you value this liquidity. And on GP-led space, we basically create a real alternative for the GP to hold on to their winning assets. I mean, if you just look at the private equity space, if they have an asset they held for five years, typically smaller managers have sold those assets to a bigger manager and they've seen the managers make a 4x and they said, if we could just uphold this asset for five more years, this 4x could have been ours. We could have continued the story, but we need to return DPI, so we are really striking a balance.

We set the external price because the GP will be on both sides of the tables. That's how you solve the conflict. But integrity is important for us as well, so in all these transactions, existing LPs will always get the opportunity to reinvest.

What is really important for us in these transactions when we do the GP-led space is we are investing alongside the VC fund, the growth manager, the PE manager on assets they know very well. So, we see these as management buyouts. We only want to do it with assets that the GP is excited to hold. So often we ask them to roll all the crystallized carry alongside us to ensure the alignment.

But I think the GP-led space should really be seen now as a third exit route for GPs. So normally it was IPO, M&A, and you're going to see the CV route keep increasing in number of exits. But obviously there will be conflicts with existing LPs because is that really what the GP was set out to do? But on the other hand, it's hard for them to find good investment and they want to keep.

Sarah Chen-Spellings:

Yeah, there was a joke earlier with Dominic from AXA Ventures who said that investing in VC is, you gotta kiss a lot of frogs, hoping there's a prince, but you find out only 10 years later.

But now with your work, you're actually able to sort of strategize a little bit, sort of the returns, what kind of liquidity looks like in the horizon.

Now, Mok, you are a seasoned investor. You've seen the markets as well. And this is a particular crunch, a very particular crunch with the highs of COVID, right? ‘21, ‘22. Some people, I'm saying it's not the people in this room, may have paid some high prices in ’21, ‘22 and now are still licking their wounds.

How are you strategizing your exits? How are you seeing which verticals are doing well at this point in time? And are they, still, you know, more strategic or do you see the IPO window opening soon?

Ku Kay-Mok:

Yeah, I think in terms of structuring exits, we truly employ certain strategies. I think sequencing investors is actually important because we invest across the gamut from early stage to growth stage.

So generally for early stage, you want financial investors because interest aligning, growing the value of the companies. But at the later stage, you do want to bring in some of these corporate investors, because from their perspective, they could be potential acquirers. But of course, you do not want to bring them too early because, you know, they may restrict the startup from competing with their competitors.

So I think there are certain strategies that we can employ, to create these kind of exits along the way.

In terms of the market exit right now, obviously for VC, theme is important. So even though it's a down market, you know, there are certain things that's hot. So generally AI is hot. So for our portfolio companies, we're investing in companies that were doing employment and customer service, application.

We have added in GPT into the business starting about two years ago. And we've also been rolling out these companies. So they're actually going IPO with a sexy story, with scale as well.

So I think there are certain ways that, as a VC, there are ways to influence the outcome, even when it's a down market.

Sarah Chen-Spellings:

Mm. So I love what you said then when we were discussing this in the prelude a little bit. You talked a little bit about being very strategic, even as a VC. I know there are a couple of new emerging managers that are doing this themselves for the first time. They may have been a spin off companies.

And what you said that was being strategic, even with your co-investors and playing an active role, not just with your founders, but also making sure the right people are on the cap table.

Can you talk to us a little bit about how you thought about this in building for liquidity longer term?

Ku Kay-Mok:

For us, we're also very strategic in terms of cashing out. So each round of financing, especially if there's a, you know, oversubscribed round, the key is, we will help these incoming investors to sort of lower the cost of acquisition. We can actually sell secondary shares to them at a cheaper price. So these are ways that we can plan things along the way. That became very strategic for all the investors that were lining up.

Sarah Chen-Spellings:

And Martin, what are you seeing? I mean, you've been at your firm for some time. You've seen the cycles.

What does this investment cycle look like? And what is your advice to GPs and LPs that are committed to venture as an asset class?

Martin Fleischer:

I think be patient if you don't want to sell. If you don't need liquidity, it's probably good to hold on at the moment, because the pricing in the market right now. On LP portfolio sales in the VC is at very, very low valuations not seen since the financial crisis, versus just a couple of years ago.

And for the GP, it's having those conversations with existing LPs to manage how important is a DPI for them, because you can create DPI for all the wrong reasons and then give away the upside. Look, it's a great market for us. We're seeing more volume than that's capital out there so we can be super selective.

So it's really a buyer's market and that's why we can get the prices.

I think we just need to see valuation stabilizes because it is difficult for people to sell at these deep discounts. But what do we do if we get a portfolio where everything, all valuations is based on 2021 valuations?

It just doesn't work, right? So that's driving the pricing at the moment is the uncertainty.

Sarah Chen-Spellings:

Yeah. And are you seeing particular verticals shine and outshine or? Really drop prices?

Martin Fleischer:

I'll be honest, I think when we do growth in VC, we do mainly in the B2B software space at the moment where you have really good underlying organic growth and a route to profitability. Where you see software evaluation have kind of held up.

The consumer space have been difficult, to be quite honest. And that's where we see some of the larger discounts if we look at the VC growth space. And we see a lot of managers, we see a lot of fund positions that's up for sale, where we see GPs really blowing a lot of money in ‘21, right?

Buying a lot of assets and I think some of these funds will, I mean, not really make a good return because of the wrong vintage.

Sarah Chen-Spellings:

Yeah, And we have some time for questions. I know this is new for some of you. So I wanted to give some time for some explorations for some questions. Are there any in the room?

Yes, Mila.

Audience Question:

So when it comes to exits, and that's the motive of objective of the fund, do you only look at the funds or do you look at the capital separately? Like there are a lot of ESOPs, you know, and which need an exit at the end of the day. That's one.

And second is that when it comes to the value terms, it may not always be from a discounted price. It may be discount in terms of the multiples that the company will be, you know, kind of gaining. So what's your take on this?

Martin Fleischer:

The prices are often expressed as a discount premium when we give the offer for LPs, but often the way we work is on a bottom up basis. So we look at the implied valuation multiples and we do bottom up on all our work.

Obviously, if you buy a portfolio of 500 underlying companies, you have to take a more macro approach. We also use, AI and data science now to evaluate those portfolios. Look, network and information is really key for us, especially in the growth and VC space, because when we are buying these assets, it's not control positions. It's like one of its positions.

So often there's other VC managers in those cap stacks. So having access to those guys can really help us price the positions. Often there's evaluation discrepancy. You can see some managers, because we have a lot of access to funds, and we can see some managers may be holding at a hundred and this VC fund is actually holding it at sixty.

Then maybe you can get closer on an NAV pricing. It is, there's a lot of lack of transparency and that's also why we can, there's a lot of good opportunities out there.

Audience Question:

On your continuation structure, how patient is your patient capital?

Martin Fleischer:

The spiel in secondaries, I mean, we do both LP portfolios and single as a concentrated continuation vehicle. People invest in us to mitigate the J curve, so we buy seeded assets looking for a little bit quicker DPI.

When we do a continuation vehicle, let's say it's a single asset. It's typically a five year structure with a few extensions. It's like a new underwriting case for the manager. So they will present a business plan to us that they say if we continue to own this asset, we think we can deliver this return to us.

And then we will structure a incentive program, a carry structure, based on that business plan. Like you would do with a management team that came to you and said, we'll invest our own money based on this plan. But it is typically a five year plan. Sometimes it exits earlier, sometimes it exits later.

Look, if it's a great component that keeps creating multiple, why not hold it longer, you know? But our funds are also like 10 year closed end funds and we also need to return capital.

Sarah Chen-Spellings:

One last question, I see it in the back of the room. Jeremy, you look like you had a question, Jeremy.

Audience Question:

Sure, I can throw one out there.

I think there's kind of a separation between what we're seeing with continuation funds with private equity and also in venture. There's a lot of exploration still happening in venture around how does this actually work in practice, and will the market actually sort of grab onto it, and sort of like how we're seeing in private equity markets.

So if you're going to sort of have a thesis on how this looks in 10 years time, will become sort of as big as the venture has become over the past 20 years, or is it going to be very selective in the hands of maybe just a few funds?

Martin Fleischer:

So different secondary managers have different strategies. Coller is very sector, agnostic. We have specialists in all fields. But you see more and more VC secondary funds being raised that only invest in VC. We'll see the secondary market will become more and more specialized.

We'll see secondary managers only focusing on software, secondary manager focusing on health care, credit real estate infrastructure and NVC. That's kind of their differentiator. Look, I think this market will only grow.

As I said, I looked in the stats. I think secondary VC market was only a couple of billions 10 years ago, and now it's like $10 billion. As private market increases, we are like a derivative. More LPs are gonna take destiny in their own hands to create liquidity, to sell the LP interest, and more and more GPs, also, VC managers are gonna use the secondary market to keep holding on to the winners to continuation structures.

Companies will just stay private for longer. And fewer good companies will be IPO'd or actually be sold to other secondary, other sponsors. I think any sponsor VC manager saying, if another sponsor want to buy this asset, I should buy this asset myself because I can make carry one more time.

As it becomes more socially acceptable. The adoption rate continues. The overall secondary markets around in PEVC is around a hundred billion at the moment, but just this market, in my opinion, could increase like five folds, become over $500 billion.

If you think about it, there's almost like 10 trillion of unrealized NAV at the moment sitting out there, and a bigger, bigger part of those excess will be secondary. So if you do the top down approach, you can easily see the route to a $500 billion secondary market.

The biggest constraint is capital. There are the deals. The deals are out there. It's just there's not enough secondary capital to do the deals. I, I can go to any GP or VC fund and ask them, the addressable market is basically all good assets owned by private market managers and say, what is your best asset?

Which asset have you owned for five years and want to continue to own? So you will see more and more GP lists being done by managers across all classes, in my opinion.

Sarah Chen-Spellings:

Yeah. And final words, from both of you, family offices in the room, some that are looking at Helsinki and Finland as the base for the new Nordics and also Europe, wise words of advice for the audience of LPs.

Ku Kay-Mok:

Okay, let me just close up. So from my perspective, I think, VC, the last decade has been the golden age and it's driven by a couple of things. Number one is, of course, cheap capital after the GFC. That's one key driving force. But actually, it coincided with mobile internet. So the rise of this cheap Android smartphone.

So if you look at the emerging markets like Indonesia. Ten years ago, the internet penetration was 15%. Today, it's close to 80%. So because of this huge addressable market and cheap capital, we have VCs booming. And it's basically driven by just spray and pray, pray and spray, it doesn't matter because it's all about coverage.

I think that phase is over because the cost of capital has gone up, it's going to be persistently high. But part of these things that we see is I think to, to the latest question about AI, we do see AI having an impact on VC funding. Because generative AI is so disruptive, you can do a lot more using very little capital.

It's like this, a transformer, you open up inside, it's actually just a small little guy doing a lot of work. That's what's happening with Generative AI. The amount of development, marketing, and stuff that's being done is actually done by one person, plus, let's say, ChatGPT. So I think there's going to be a reduced demand for a lot of this early stage capital, just because AI make, All these programmers market is so much more productive on the supply side.

On the demand side, what's happening is I think politicalization has taken over as, you know, the driver of free trade instead of digitalization. So the supply chain is going to be reconfigurable worldwide. A lot of supply chain for, whether it's green tech, whether it's battery, electric vehicles, robotics, they will move to the global south.

So I think there's a lot of re-industrialization that you're seeing in countries like Vietnam, Mexico, Brazil, Saudi Arabia. these are new opportunities, but of course, the difference is actually these are industrial projects. so maybe the more appropriate model instead of just, you know, cheap asset like VC, it might be venture building.

So I do think that in the global South, a lot of VCs will actually evolve from really purely BC to become more like quasi private equity funds. So they're investing for deals that has, let's say, a 5x return instead of venture deals that has 100x return because it's just a different world with high cost of capital.

Sarah Chen-Spellings:

Martin?

Martin Fleischer:

Yeah, look, we love the Nordics. I'm from Denmark and I spend a lot of my time with the GPs in this region. On the GP side, there's such a strong ecosystem, both on PE and VC. So many great companies come out here, so that's why I'm also in Helsinki, getting to know all the VC and PE managers to see if we could do some business together, because if you have VC, there's a lot of winners coming out of this region, and it's great if we can continue to back them as the companies scale up, so it's a great deal space.

Sarah Chen-Spellings:

Thank you.

And with that, round of applause, ladies and gentlemen. Exits and secondaries for this venture cycle.