The first dedicated fund to focus on the purchase of venture capital assets was the Venture Capital Fund of America, or VCFA, founded by Dayton Carr in 1982. VCFA focused on the purchase of LP positions in venture capital funds to provide the Limited Partner investors in those funds liquidity well ahead of the projected fund liquidity. This new type of fund followed a long history of secondary transactions in funds focused on buyout, growth equity, real estate and other illiquid private equity funds. As commitments to venture capital funds dramatically expanded in 1995 – 2000, many more private equity secondary funds entered the market to purchase LP interests including Lexington Partners, Coller Capital, HarbourVest and others. These funds became quite large in size and focused on larger transactions, typically $100M and larger.
Following the dramatic increase in the number and size of Venture Capital funds making investments in private companies during 1995 – 2005, there emerged a significantly larger opportunity to buy interests in individual companies, or ‘secondary direct’ investments. The first fund to focus on these secondary direct investments was Industry Ventures of San Francisco, founded by Hans Swildens and Justin Burden, with its first large fund of 2004. Several other funds have emerged that also focus on secondary direct investments including Greenspring, W Capital, 137 Ventures and others.
Today, there are a number of generalist venture secondary funds purchasing assets, as well as small amounts of shares available through web-based broker-dealers such as SecondMarket or SharesPost. The challenge with these web-based platforms generally is that there is a vast information gap between the current company financial status and what the buyers or sellers understand. So while there may be many sellers wanting to get liquidity for shares in a highly valued unicorn company, the potential buyers do not have access to company financial information to make an intelligent purchase.
As the secondary venture capital market matures, the ability to achieve differentiated returns will become more challenging. With more capital dedicated to searching for these great opportunities, the price of acquiring assets on a secondary basis can become more competitive and purchase prices can increase, lowering overall returns.
We have seen the evolution of the traditional venture capital model go through this maturation process before. In the 1980s and 1990s, when venture capital really started to expand, most firms were staffed by generalist investors that were typically entering venture capital after careers as lawyers or investment bankers. These generalist investors did not have work experience in particular technology industries and tended to make investments across a very wide array of markets. As the venture industry matured, the successful venture capital funds turned to a strategy of hiring executives and successful entrepreneurs as general partners to focus on making investments in specific markets. Funds began to specialize in areas such as biotechnology, clean technology, enterprise infrastructure, software, consumer products and services etc. Those funds that hired great managers with deep industry contacts thrived in their areas of focus.
The secondary market is ripe for a similar change in investment strategy. Today, almost all venture secondary funds are staffed by generalist investors, typically with backgrounds in law or investment banking. Returns will inevitably decline if these funds do not invest smarter and better than their competition. Only by having deep industry experience and contacts can a secondary fund uncover the hidden opportunities and value that drives return.
The key aspects of delivering better returns in venture capital include deal sourcing, deal diligence to determine whether an investment has the chance of meeting return targets, and closing the transaction with the seller at an agreeable price. In all these aspects of success, deep industry contacts and understanding will dramatically improve the outcome. Focus brings better opportunities to be considered, focus and contacts allow fast determination of an investment potential, and focus brings an ability to work intelligently with sellers to come to an agreeable investment.