Why secondaries are here to stay

Ravi Viswanathan of NewView Capital says secondaries are becoming a structural part of the venture market, not just a short-term solution.

Expert analysis by Ryan Hibbison

Everyone in the venture industry is talking about liquidity right now. LPs are pushing GPs to deliver distributions on their aging and growing portfolios, GPs need to appease their investors as they go to market with new funds and companies need more runway as they try to keep up with valuations they raised at in the post-covid market to avoid a down round.

With M&A transactions remaining sporadic and the IPO market stalled, VCs are increasingly turning to the secondaries market to manufacture exits.

Ravi Viswanathan, founder and managing partner of secondaries specialist NewView Capital, tells Venture Capital Journal that the secondaries market as a whole is growing, and that the share taken up by venture secondaries deals is increasing even more rapidly.

“The secondaries market now is around $150 billion-$175 billion, and about 90 percent of that is buyout, but a few years ago it was 95-97 percent buyout,” he says. “Our research suggests that the secondaries market as a whole is growing at around 15 percent per year but the venture share is growing at 20-25 percent, so that piece of the pie is growing even faster.”

Direct secondary share transfers, GP-led strip sales, continuation funds and LP fund stakes are some of the most popular strategies venture firms are utilizing to generate cashflows from their portfolios. But is the popularity of secondaries just a short-term solution to current market pressures faced by venture GPs? Viswanathan says no.

“There is a moment-in-time interest for sure, and in the next 12-36 months you’re going to see some intensification,” he tells VCJ. “But our view, and it’s becoming more real every day, is that in five to 10 years for venture the options for exits will expand from IPOs, strategic M&A and sponsor M&A to include secondaries. I think that venture is clamoring for more ways to make the avenues for exit a little more balanced.”

Following a nearly 15-year career at New Enterprise Associates, Viswanathan founded NewView in 2018 specifically to acquire a portfolio of 31 companies from his former firm through the secondaries market. He raised $1.35 billion to acquire the portfolio and now manages $3.1 billion, which he invests through primary, secondary and hybrid deal structures in technology companies.

Viswanathan’s acquisition of the portfolio from NEA highlights the issue that he says is what will keep the venture secondaries market going for the long term.

“Twenty years ago, if a company had $100 million in ARR it could go public, but now its more like $500 million [in ARR], so whatever you thought could be an IPO pipeline is actually shrinking because that bar is going higher,” he says. “It really is just a math problem. You have about $3.8 trillion in venture AUM and about 60,000 private companies. If you look at how much dollar volume or how many companies are going out to IPO or M&A or shutting down every year, it’s like a 10- to 20-year backlog, so that tells us that this is not just something that is going to be a moment-in-time thing.”

The portfolio bloat faced by venture GPs extends well beyond public market cycles, and is proof that the industry needs to evolve to better serve LPs, companies and the GPs themselves.

“We foresee a world where, if people actually do this active portfolio management, we as an asset class become better fund managers,” Viswanathan tells VCJ. Through active portfolio management, "we’ll get DPI, we’ll get bandwidth and resources back to reinvest and we’ll actually improve our net returns. We’re not at that level of sophistication yet. We need to get there, but it’s hard when you’ve made money for five decades adhering to the power law.”

The power law has been a tenet of venture investing for as long as the industry has been around. Spread your capital wide, take minority positions in a large number of promising companies and one or two will achieve a high-enough multiple to cover the majority of other investments that fail or achieve smaller outcomes.

The issue, Viswanathan says, is that power law investing can lead to one or two companies making up the large majority of a given fund’s net asset value, increasing risk in the already high-risk world of early-stage investing.

“A lot of the early-stage funds I know say, ‘Why would we sell our winners? Our LPs would say the same thing.’ But it’s not that cut and dry,” he explains. “These 100x companies – in some of [the portfolios] it’s like 98 percent of the fund NAV – if you have 98 percent NAV concentration risk, you can cut out 5 percent of your position and that could be a huge return. And, just for your own mental health, it would be good to take some of those chips off the table to normalize that NAV concentration.”

Viswanathan emphasizes that power law investing is not dead. However, he says, “Really good LPs realize that the power law still works; the innovation engine is still venture-backed companies,” but the normalization of portfolios is already happening as LPs begin to put more focus on DPI over multiples, IRR and TVPI than they have in the past.

While the conversations he has with venture GPs around utilizing the secondaries market have already changed from when he started NewView, Viswanathan believes it will take a structural “mindset shift” for firms to stay competitive as the market evolves.

“What you need to do is this – there’s the firm and there’s the individual companies, and there needs to be a layer inserted at the portfolio,” he explains. “What that means in practice is we basically started having quarterly business reviews to go through the portfolio and actively manage it. Then you start decoupling the emotional attachment that a company has to a portfolio, and it’s tough for firms because we’ll never give up on a company, but it's not giving up so much as, ‘Are you the right owner at that stage?’ That mindset shift [is needed] to really be like some of the PE folks who have done it well, looking at all options creatively and not being so single-threaded and dogmatic.”

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