Silicon Valley venture capital firms are rushing to create private equity style structures in a race to protect their portfolios and return money to investors.
VC funds that invest in tech start-ups typically run for 10 years with an option to extend for two years — at which point their backers expect a return on investment, without which they can force a sale of portfolio companies or shut them down.
Providing those returns has become problematic, as a funding boom in fledgling tech companies during the pandemic has been followed by an uncertain economic environment that has led to start-ups staying private for far longer.
In response, dozens of tech investors — including $25bn venture firm New Enterprise Associates and New York-based Insight Partners — have set up or are establishing “continuation fund” vehicles, according to people advising on the plans.
Continuation funds, which are common in private equity but rare in venture capital, are a secondary investment vehicle that allows them to “reset the clock” for several years on some assets in old funds by selling them to a new vehicle that they also control. This helps a VC fund’s backers, known as “limited partners”, to roll over their investment or exit.
“It’s a good time for this kind of structure,” said Hans Swildens, founder of VC firm Industry Ventures. “During the next year, if the IPO market doesn’t function and M&A is light, the only way for VC firms to [distribute funds back to investors] is . . . secondaries.”
Others are undertaking “strip sales”, a form of restructuring in which a slice of a fund’s assets are sold to new investors, as pressure increases to return money to limited partners.
“Unless you have been really conservative in your reserves . . . every venture firm is in need [of liquidity],” said the chief operating officer of one multibillion-dollar Silicon Valley firm. “It is a real problem. Most funds are 10 years old and have scraps left they can’t fund.”
Financial institutions, including Goldman Sachs and Jefferies, and large private investment managers such as Industry Ventures, StepStone Group and Coller Capital have also been in talks with the venture groups with offers to fund secondary transactions, venture capitalists said.
Secondary funds have raised $64bn this year in order to buy up stakes in portfolio companies from venture and private equity investors, according to Jefferies — more than the combined total raised in 2021 and 2022.
“For a lot of folks we are now having exploratory conversations with, they have an absolute need to generate distributions,” said Matt Wesley, head of private capital advisory at Jefferies. “Given the dearth of exits for companies owned by venture firms, certainly the groups who are registered [as investment advisers] are actively exploring continuation funds.”
UK chip designer Arm, US grocery delivery app Instacart and San Francisco-based market automation group Klaviyo listed on New York exchanges in September, ending an 18-month drought in tech initial public offerings. However, trading has been mediocre at all three companies, prompting start-ups to delay their listing plans.
“The performance of the handful of companies that have gone public has intensified some of these conversations among venture firms,” said Joe Binder, a private funds partner at law firm Debevoise & Plimpton. “People had hoped there would be a lot more enthusiasm [for tech listings] but it has waned and so people are turning to alternative solutions.”
However, continuation funds can be unpopular with limited partners which must decide whether to continue to back a VC fund for several more years, or sell their stake, typically at a discount. There are also regulatory restrictions that make it difficult for venture firms that are not registered investment advisers (RIAs) to set up such vehicles.
Insight Partners’ continuation fund allowed it to shift 32 companies from its funds into a new vehicle over a five-week process, according to a letter from Jefferies advertising its services to venture clients. The transaction resulted in $1.3bn being distributed to Insight’s limited partners, the letter said.
In May, Tiger Global, which manages more than $50bn, hired secondary investment advisers Evercore to launch a sale of parts of its venture portfolio, with a strip sale being one option for a deal. Offers from buyers did not meet the valuations that Tiger expected and a transaction has not been completed, according to people close to the plans.
Quiet Capital, whose early investments included Airbnb and Robinhood, raised $100mn from secondary investors in such a “multi-asset tender offer” in late 2021, according to the Jefferies document.
The transaction allowed Quiet Capital LPs to sell half or all of their stake in the fund to new institutional investors at Goldman Sachs Asset Management and Blackstone Strategic Partners — both secondary investors — at a premium, according to a person with knowledge of the deal.
Dozens of large venture funds such as Sequoia, Andreessen Horowitz and General Catalyst have become RIAs in recent years. The regulatory designation made it easier for them to trade in cryptocurrencies, debt and in secondaries, in which they can trade stock with other private investors.
“There used to be clear lines between what a venture capital fund and a private equity fund was, but now all these strategies are converging,” said Binder. “Venture funds . . . are doing the sort of thing you could never have imagined 10 years ago.”
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