Our Huddle
the ihuddle community
Time for the little guy to partake!
Walk with giants!
In the last decade, venture capital has finally become large enough as an asset class to drive demand for liquidity.
That sounds like an incredibly boring way to begin a blog post but it’s surprisingly important, which is why we’ve decided to spend a bit of time this week talking about it. This one is all about secondaries in venture capital funds and how it’s a prime asset class for smaller investors.
A lot of funds (whether they are private equity funds, credit funds or venture capital funds) are set up as limited partnerships. This is mostly done for tax reasons. A partnership is tax transparent which means that the fund does not have to worry about how to treat distributions made to its investors. The investors are paid gross and the onus is on them to declare tax in the appropriate way in their jurisdiction. It allows funds to market their strategies to a number of investors in different parts of the world. The investors are called limited partners or LPs.
In more traditional asset classes like private equity and private credit, a pretty strong secondary market exists. Large funds allow their LPs to sell the interests to other investors (subject to minimum size constraints). This is a pretty key distinction – new investors are not buying a stake in a specific asset. No, no – they are buying a stake in a fund from an existing investor. Typically, this is done for 2 reasons
- The existing LP needs liquidity (fancy words for “I need cash for other stuff”)
- The incoming investor either missed out on the original issuance of investor participation OR wanted to wait and see if the fund was any good before he took risk on the fund manager. This allows the incoming investors to take advantage of the diversification in the fund.
The sale of an LP interest is a market transaction. The incoming investor is willing to pay a certain amount, the exiting investor needs a certain amount of cash and the two agree terms. Really, its just a super sophisticated marketplace
Now there’s a new asset class out there entering the secondaries space (Huzzah! Happy New Asset Class everybody!!) in a meaningful way – venture capital funds!
Purchasing LP stakes in a venture capital fund used to be uncommon for a number of reasons:
- The asset class was not large or deep enough – more on this later!
- Fund lifetimes used to be long enough to see at least or or two portfolio companies exit. Now however, that lifeline has changed. The mean time to exit by acquisition in 2019 was 6.3 years (http://www.ianhathaway.org/blog/2019/1/9/time-to-exit) up from 4.6 years in 2005. Similarly, time to IPO has increased from 4.8 years in 2005 to 6.6 years in 2019. This is part of the reason for the SPAC boom (though we can all agree that the primary reason is the central banks cranking up the printing press). In general, this does mean that LP money is locked in VC funds for long periods of time that negatively impacts investment schedules and liquidity.
So why is this important and why are we banging on about it. The answer is simple – SIZE
Look, in theory iHuddle works well for secondary stakes in private equity, credit and property funds as well. But, those sizes are still quite large. An existing LP may want to sell $10 million of their stake in the secondary market and ten iHuddle members can, in theory, put in $1 million cash each to buy this stake via iHuddle. But it’s still $1 million per person! That is a LOT of money for Regular Joes (in fact, let’s just agree that if you can sink $1 million on an investment, you’re well on your way to becoming an Irregular Joe). Sure, you could in theory find 100 friends to put in $100k each but how practical is that?
Venture capital funds are different. You have a number of funds from those with total assets under management (“AUM”) under $1 million to those like General Atlantic (the largest VC fund at $31 billion AUM). But that is still small compared to credit and private equity funds. The big boys in those categories are well into the hundreds of billions (which is kind of ridiculous when you think about it).
Most VC funds are well under $1 billion in terms of AUM. The LPs in those funds are very happy selling secondary stakes for $1 million or under. Now all of a sudden it suddenly becomes a game the little guys can play in. We can finally compete with the big boys!
It’s suddenly possible to get 5 – 10 friends and cobble together $500k in a trust and buy a secondary stake in a VC fund that gives you diversified exposure to the next Uber, Deliveroo, Revolut and Seedlegals. That could make all the difference to that college fund for your kids.
Check us out at:
iHuddle – Co-Investments and Club Deals
Bring us your ideas, bring us your deals – we’ll collate them for you, manage the trust and make sure that you can even on-trade your own exposure to the LP in the venture capital funds you’ve invested in.