Secondary Financings Offer Lifeline In A Slow Exit Market

In a slow exit market, investors have had to become more creative in finding ways to bring cash back to their pockets and those of their limited partners.

Secondary financings have become one way to solve the liquidity crunch facing the venture markets and its backers.

“For so long it was taboo,” said Larry Aschebrook, managing partner at G Squared — an investor in growth stage companies in primary and secondary financings — on the newfound popularity of secondary financings. “Now it’s a necessity.”

In August, the Chicago-based firm closed on its $1.1 billion sixth fund, close in size to its 2020 largest vehicle, its $1.2 billion fifth fund.

“It’s a pretty good time to be doing what we’re doing,” said Aschebrook. “The companies are more mature, which has less risk, and the discount is good compared to the public comp set which you’re obviously valuing companies against.”

Sequoia Capital recently completed a $861 million financing to buy its limited partner shares in 14-year-old Stripe at a $70 billion value — the payment provider’s most recent 409a internal value for employee shares. The purchase price was well above the $50 billion the firm was valued at in March 2023, but below its 2021 value of $95 billion.

“I think the LP/GP relationship at 10 years, is broken,” said Aschebrook. He anticipates more permanent vehicle capital structures in venture, a change that Sequoia Capital made in October 2021.

Changing times

The increase in secondary financings is driven by the current market, but also the difficulties of being a public company. He cites the strain on management, the focus on 90-day increments versus long term incremental shareholder value.

And it is less compelling for companies to list, as SaaS public market values are low compared to historic norms.

“Why would Wiz go public today?” he asks. And for market makers, “companies that are going public, sub $10 billion aren’t super interesting to most of them.”

Market shifts

In 2021 and 2022, secondary shares were trading at a premium to primary shares, said Aschebrook. During that time G Squared shifted to a focus on primary investments. As a result, the 2020 vintage fund was closer to 55% secondary and 45% primary investments. In 2023, the firm allocation went back to 70% secondary and 30% primary.

The current market is more like 2015 with options to deploy capital in mature high-quality businesses at a 30% discount to intrinsic value, by being a liquidity provider, he said. As a firm, G Squared is not taking as much execution risk as the companies are well established. The risk is in pricing.

Decade and counting

G Squared looks to invest in fast-growing, dynamic companies that are 10-plus years old, said Aschebrook. In any normal situation, most of them would be public. Instead companies are deciding to stay private for the next two to three years.

Aschebrook describes a scenario where an investor invested in the A, B, C and D rounds in a company. Since then, a company might not have raised funding in three years, as it does not need to, and an exit is not on the table in the near term. But investors need to return capital to their LPs.

G Squared partners with entrepreneurs and the C-suite to provide shareholder liquidity and employee tender — to reward employee effort and support retention. Companies generally do not want employees selling shares on an open market and prefer to have known shareholders. Typically G Squared will structure an offer and work with the company to identify shareholders who would be interested in increasing their stake.

More so than employee offerings, the majority of shares purchased by G Squared come from other managers who could be on the board, have invested over several funds, and want to return 10% to 20% to their limited partners to show the value of an investment.

And there are lots of current opportunities, even if the market was flooded with secondary buyers. “If the company’s got a $20 billion private valuation, there’s $17 billion worth of stock out there to go buy,” he said.

Ultimately, G Squared needs to provide liquidity. The firm is focused on distributed to paid-in capital, actual returns and not a valuation mark-up from a follow-on funding. Their North Star is 2x DPI in a 5- to 7-year period, said Aschebrook.

Illustration: Dom Guzman