PRINT THIS PAGE Secondary sales remain a mystery to most investors
13/09/2006. Source:Israel Venture Capital Journal (IVCJ).
 Secondary funds can offer several benefits to investors that desire liquidity or that otherwise wish to sell their holdings in private companies, says the Israel Venture Capital Journal. Yet, many investors are simply unfamiliar with secondary funds or have outdated perceptions of how they operate.
Abe Finkelstein and Amit Frenkel of Herzliya Pituach-based Vintage Ventures look to unravel the mystery.
Secondary transactions growing
The sale of limited partnership interests in venture capital funds as well as portfolios of direct holdings in private technology companies (collectively called secondary transactions) have become increasingly common over the last five years. This reflects huge amount of capital raised by venture funds in the late 1990s and the subsequent tech market downturn.
While the market has no doubt grown more active, and secondary sales have become a more acceptable avenue for all parties, transparency remains limited. Sellers, for the most part, do not want to publicize the fact that they are selling, and buyers and fund managers are likely to adhere to confidentiality. As a result, sizing the overall secondary market is challenging. Nonetheless, secondary transactions continue to take place at record levels. According to Paris-based fund raising and secondaries trading specialist Triago, the worldwide market for secondaries was probably $9.6 billion in 2005, up 25 percent from 2004, and is likely to continue growing at that pace through 2006.
Just as the primary Israeli private equity market is a relatively small portion of the overall global private equity market, the secondary market is also relatively small. According to data from Vintage Ventures (the only active local secondary player in Israel), the secondary volume in the local market was roughly $60 million to $75 million in deployed capital in 2005. Nonetheless, the Israeli secondary market remains active. In fact, according to a January, 2006 report by Deloitte Israel, 91 percent of local fund managers indicated that they expected secondary activity to increase or remain constant during the next six months.
Further, in contrast to foreign secondary markets which are largely dominated by buyoutrelated transactions, Israeli secondary sales have nearly all been venture-oriented due to the relative size of the local underlying assets. Venture should continue to dominate local secondary transactions going forward, but the recent increase in the number of Israeli buyout funds should result in buyouts becoming a growing portion of the local secondary market over time.
The sellers are changing
As the market has evolved, the types have sellers have also changed. Initially, following the burst of the tech bubble in the early part of the decade, a large proportion of the sellers could be categorized as “distressed.” Specifically, these sellers could not make future capital calls in the case of limited partners, or could not continue to put funds into their private technology portfolios and knew that their holdings would get wiped-out or severely diluted. While today these “distressed” situations still arise occasionally, the majority of remaining investors are not considered distressed. Most sales today are driven by the desire to obtain liquidity in still uncertain private technology holdings and to better manage overall investment portfolios.
Specifically, while the technology market has certainly improved since the early part of the decade, they remain uncertain. Acquisitions of technology companies remain sporadic and relatively small (>90 percent of technology M&A remain under $100 million according to CIBC Investment Banking), and the hurdle to an IPO has risen significantly, remaining open only to the best companies. As a consequence, the time to exit is longer than some investors originally anticipated. Furthermore, some investors are interested in reducing their exposure to 1999-2001 vintage funds and “roll-over” their exposure to the more promising 2005-2007 vintage venture funds.
In addition, many of the venture funds from the mid-to-late 1990s are coming to the end of their lives, and the individual fund holdings will likely be distributed to LPs. Most LPs do not have the desire, time, capital or even the ability to manage small holdings in private companies. As a result, secondary transactions remain a popular option for funds at the end of their lives.
Despite a variety of sellers, secondaries remain a mystery
In 2005, Vintage Ventures, completed transactions with a wide-variety of sellers with a variety of motivations. Purchases included a portfolio from a holding company that decided to completely exit technology investments, an LP unit of a European IT company that wanted to divest from non-core investments, and an LP interest from an individual investor seeking liquidity in his non-liquid private equity holdings. Despite the rise in secondary activity, secondary alternatives remain a mystery to most investors. This is especially true for individual investors and corporates. Many of these investors (some of whom invested in venture capital funds for the first time in the mid to late 1990s) have not conducted or even explored the secondary option.
A large portion still assume that buyers only offer upfront payments at deep discounts (e.g. payments at a discount of 50 percent or more relative to net asset value), or offer no cash upfront and only structured deals. Today, however, funds like Vintage Ventures are paying more cash upfront in transactions, and often at more moderate discounts to net asset value. Such transactions provide the seller immediate liquidity, remove future uncertainty related to the asset, and eliminate the need to contribute any outstanding balance (likely to be called over the next 12-18 months in funds from 1999-2001).
The immediate liquidity and “freeing up” the future commitments also allow investors to manage their portfolios and direct capital toward other investment strategies (e.g. real-estate, hedge funds, etc.) or, as noted above, even to venture funds that are raising capital today – arguably a much more attractive vintage. In addition, a good secondary, especially one focused on a local market with extensive experience in that market, can wrap up deals with a very high level of certainty in a few weeks – not months – and therefore provide the investor with maximum flexibility in terms of investment timing.
This article appeared in the Israel Venture Capital & Private Equity Journal (IVCJ). IVC Research Center publishes the Israel Venture Capital & Private Equity Journal, a quarterly review of trends and developments in the Israeli-related venture capital industry. IVCJ, distributed worldwide, is dedicated to provide wide-range coverage of Israel's venture capital industry. For more information please visit www.ivc-online.com
|
