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The rise of direct secondary opportunities: an untapped space

Updated: Jun 16, 2022

Venture Capital breaking all records in 2021

The venture capital market has evolved and grown substantially over the years with 2021 representing a record year in terms of funding. Global venture capital funding hit $621B in 2021, more than doubling compared to 2020.

The number of $100M+ mega-rounds surpassed 1,500 deals for the first time in 2021, shattering last year’s record of 630.

From 2015 to 2021, over $2T have been invested representing a significant increase of liquidity allocated in this asset class, still largely unrealized. This implies a large amount of liquidity allocated in the VC asset class with GPs ready to deploy capital into successful businesses with a particular focus into late stage deals.

The activity of Venture Capital investments has largely contributed to the constant increase of valuations in VC backed companies with the surge of new unicorns.

The global unicorn count hit 959 in 2021 — up 69% from 2020, mostly driven by rapidly rising valuations of late stage deals. The combined valuation of the total unicorns in 2021 is around $3.3T.

This increase in holding period, driven by a constant increase in valuations, leaves founders, early investors with more paper wealth and illiquid capital.

What is a direct secondary?

The direct secondary market is an untapped space driven by the combined effect of the rise of valuation of VC backed companies and the increasing holding period from shareholders.

A “secondary” usually happens at any time between financing rounds when the company has achieved significant revenue or traction and is already seen as a potential “leader” in its respective market space, on the way to an IPO or a major sale.

It offers sophisticated investors the opportunity to get exposure to the best tech and disruptive companies by providing liquidity to founders and other shareholders before the exit, allowing to cash in part of today’s value creation.

In the past companies were going public with smaller revenue/valuations allowing investors to cash out upon over a short period of time. Today, only around 10% of unicorns complete an exit or an IPO each year with an average holding period of 10 to 12 years.

All this created thousands of “paper millionaires” with the need to protect part of their wealth and get a reward for their strong involvement before a total exit. Also VC funds are facing these liquidity issues and have the need to monetize their shares in order to optimize IRR and improve distribution path to Investors.

Estimating the size of the direct secondary market

We believe that the direct secondary market will follow the same evolution of the LPs stake secondary market (investors in PE funds selling their commitments) which has now almost reached a maturation stage.

The LP stake market grew from 1% to 2% of Global Private Equity Assets Under Management (AUM) over the last 10 years, expected to reach $111B in 2021. Originally it was mostly limited to transactions among LPs but recently, fund managers (GPs) started to support actively LP liquidity by organizing GP led secondaries.

The direct secondary market is not yet mature and very similar to what was the LP stake market at the beginning of last decade. Assuming a 1% penetration rate thus appears conservative. Applying this percentage to the value of Unicorns companies, the estimated direct secondary market size is ca. $30B. Given Secondary Capital’s focus on companies valued between $1B to $5B, we estimate the total addressable market around $15B.

Direct secondary represents an unserved space with favorable market conditions to achieve high returns with shorter holding period and lower volatility.

Sources: CB Insights Venture Reports, 2021; CB Insights Global Unicorn Club 2021; Global Secondary Market Review 1H21, Jefferies; Preqin Pro, Greenhill Cogent 2021


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