E246 | EUVC | Key Insights on The State of the Secondaries Market & How To Win

30:39A lot of those businesses are now coming back to market, looking to raise more capital. And the structures of those primary financing rounds can be very onerous on the existing securities in those businesses, particularly so for common stockholders. And I think that's why you've seen, you know, a lot of institutional buyers rethink where they want to buy in the capital stack. And for that reason, I think it's become a little bit more different, sorry, difficult to go sell a common stock position. So, you know, I think in terms of where we're focused today, it's probably more on senior preferred securities, LP interests that consist of preferred securities, where we feel good about the residual value of those securities in a different sort of exit environment than what we saw in 2020, 2021.

31:31I'd love to ask you, Joe, if you, because before you said that the way you often buy secondaries in assets that you already know, is that how you think about it purely? Or do you also source outside of the existing pond and look like that? Well, so I should categorize. Relative to Kemper and industry, we have a tiny secondary program. And it's a part of our primary program, if you will. So we invest in funds, we co-invest in companies. And the way we've always executed secondaries since the day we started was really just to tell our partners, fellow LPs, the VCs we work with, company founders, hey we're in this for the long term with you but things happen along the way we know that so if you ever want to exit or need to exit or you know you hear about another LP looking injection let us know and it always is easy to buy more of something you know and love already so that's the you know we we have a lot of data we are sitting on a lot of LPACs we sit on a lot of companies and so on.

32:44And so that's where we really start. And there's already a lot of flow just in that. We have over 2 ,000 companies in Europe in all portfolios. Our GPs have a couple of hundred funds they operate. So just sticking to that is already a really big flow. And it's been super, super value additive to everyone around the table because a lot of the GPs we've done secondaries, but they never did a secondary before. They don't know what it is. They're young firms themselves. So we finally do a lot of education. Well, here's how it works. And here's what we would do. And then pricing is always, you're kind of hinting at it, Kemper.

33:25I think everybody has the last round valuation in their minds. Well, that's what it's worth. And companies are not worth A or B. They're worth what someone's willing to pay, either on a primary round or later, just like the stock market. Pricing is what somebody bought the last share at, right? So what we often find ourselves saying is, well, if we own this asset today and we look forward, what do we think could happen? When would it actually do? What's your price? And if you kind of discount back by your target return, you have the price you'd be willing to pay. And you think, well, we often find ourselves also saying, look, this is what we'd pay today.

34:04If that's interesting for you, great. If it's not, let's talk again in three or six months because the world changes. You know, the outlook changes, the revenue curve of the company grows, and we'll reconsider that in three months, six months. So it's also a very point-in-time kind of analysis of buying things. If I may jump in, guys, I'd love to pull in and reel in some of the questions and comments we've received so far. And to anyone listening in, please keep them coming. I'm doing my best to sort through them and pick the most relevant ones for everyone. I have a question that I'll put out there with our panel here, which comes from Christian Evans.

34:42Christian is joining from the US. Thank you for joining. And based on his LinkedIn profile, I guess he's the founder and an aide. And his question is around the fact, I'm going to read out now, most retail investors struggle with completing proper DD and underwriting of these companies because we don't have access to the cap table, executive team, financials, et cetera. So with that being said, how do you bridge that gap to complete property DD for these companies? I'd like to reframe this question slightly, not necessarily retail investors, but less experienced investors or new investors into this space, because that is a bit of a broader, a broader, a broader, I don't know, group of, of potential individuals and organizations.

35:20Martin, I'd love to really win and challenge you with this one. What, how can you bridge this gap? Yeah, this is one of the earliest problems that we started addressing, and that is how do we increase the level of quality of data that we produce at flow for parties to be able to make a good assessment whether to invest or not. And so we are a data processor compared to all the parties in the market that scrape and look for some truth in scraping the web. And so as a result of that, we consistently process full financial models, are part of the due diligence cycle, have a countess check for certain counting errors, etc.

36:13And in that way, we can actually deliver a very high quality data set for anyone in a very easy, usable construct. So on a mobile phone, for instance, like you're used to investing in crypto, it's the same type of experience. You probably have even more information and at your fingertips than you would have on a Revolut, for instance, investing in public stocks, because you might have month-to-month data, for instance. So I think this level of consistency of creating quality data for anyone to make an assessment whether to invest or not is really important. That's around the technology piece of things.

36:52But I read a question earlier as well, which is around this data information asymmetry problem in the markets. And I love that problem because it's a very interesting one. And I think I completely agree with everybody else that you shouldn't fully democratize information to this, that everybody has the same set of information because that's not how it works. The market would actually come to a standstill if you do something like that. I think people should have access to the information if they have access to that information. And we just built a lot of tooling actually to process that more consistently and to build up a data warehouses and the permission actually to that particular data warehouse of their ecosystem, I mean the ecosystem, for instance.

37:38And so what we did do is say, if we run the primary market transaction on our platform, we run it through a vehicle with a unique type of SPV structure that's transparent. But more importantly, it has data warranties on there. And the data warranties allow for the owner, actually, of the stock to bring somebody else up to far with the same information to make that assessment. And so with that combined with the technology, with pinpointed control, and with an alignment, actually, of the companies itself, so that they can start making money out of running secondary, even if it's a little bit money.

38:23But I think that full alignment of the players that are necessary actually to create liquidity, whilst not ruining the markets by flooding it with everyone with the information, I think that's the right construct. So you don't change the way people currently operate. This makes it a lot easier for people to run both primaries and secondaries. And when we run a primary at the moment, we say, okay, let's do it through the rail. where we have secondaries by design. And we do the same kind of principle with funds. When funds are coming now to new fund products, it's more flexible. It is rails where it has secondaries by design, both from a technical perspective as well as from a financial engineering perspective.

39:06Kemba, I'd love to ask you almost the same question, right? But from the non-tech angle, but from the investor angle. So, because the question is really, that's how I think about it at least. how do you go about diligencing a deal and finding the right price for you. And I'd love to understand your take on this and be as concrete as you can when it comes to tactics and everything. And if I might, sorry for interrupting there, Kemper and Andrea, but if I may, I remember the first time I looked at a secondary and someone in this panel helped me through that process. I learned something incredibly interesting, which is how important the timing is in that process of biligencing.

39:49So what I mean there is if we're talking about a fund secondary, it's very different if it's year 3 or year 10, right? It's a completely different DDE project. Same applies for startups, right? Whether they're on the stage. So Kemper, I'd love if you could also expand a tiny bit on that. That would be super insightful. Yeah, that's a great addition, David. And yeah, I just want to maybe answer your question, Andreas, as well as Christians from my perspective. It's a really good one. I mean, secondaries are not just hard for retail investors. They're hard for professional investors too. And not to be too repetitive because I think we've said this a bunch, but that's because good information is tough to come by in this market.

40:31I think Joe just said this really well, but there is a huge advantage to having an existing sort of broader platform when you're doing secondaries. We, like Isomer, invest in funds, invest in companies and do secondaries across the spectrum of tech. You know, that gives us a really interesting hunting grounds from a sourcing perspective, but also, you know, a massive data set off of which we can price a huge number of companies. We've got about 7000 underlying portfolio companies today. So if we're looking at a portfolio, there's a pretty good chance that we have exposure to one or multiple of those underlying companies.

41:15And we get some level of financial reporting on those businesses, which gives us a big leg up. If someone, you know, if an LP calls you and says, I want to sell you my fund interest. Oftentimes, the best set of data that you're going to get from that LP is the set of fund financials, which may just list the name of the companies and the cost and the value of those businesses. in their capital account statement without any substantive information on the businesses themselves. So I think that's, you know, as a retail investor or any investor without that sort of broader data set, I would have to imagine that buying that interest and pricing it accurately would be nearly impossible.

41:55So we, you know, we leverage that sort of broader platform that we have to identify companies that we think are interesting, but also to do our DD work. That platform approach to venture secondaries, I think, is what works best. And for that reason, there is a big incumbent advantage in the market. You just said something, Kimber, that I have to ask you about. You said it without that data set and insight, I think that would be almost, a secondary steel would be almost impossible to do for me. Does that mean that if you were not with industry, but you had your own, say you had 5 million in the bank or something like that, you would say, no, I'm not doing secondaries because it's too hard?

42:40It's a good question. There was a sharp increase in retail activity in venture secondaries in 2019 through 2021, basically, because the category was producing fantastic returns. Those were record years of liquidity for the asset class. and you could go buy common stock and sometimes that company would IPO in three to six months and you could make a fantastic return. The equation changes a bit in today's market or even just a normalized market where you do, Christian asked about, how do you buy a direct secondary if you don't have the cap table? It's really tough because you don't know where your security sits in the stack.

43:25You don't know what proceeds that security is entitled to at different exit values, different exit types. I would say with$5 million to invest in venture, I think that there are probably more sort of risk-advantaged approaches to deploying that$5 million where you get a little bit more diversification. You invest in a fund that does what we do, what Isomer does. There are plenty of them who are really good at it. I think What if I get a secondaries in one of those? No, I'm kidding you Joe, I want to ask you a question and that goes to this whole notion of whether you can time the market or not because Cambridge said we had a lot coming in from 2019 to 2021 because secondaries performed very well and obviously that then means that there were people that did make a fortune in that period by getting in and getting out.

44:27Would you say that secondaries is different from normal venture in the sense that the rule about not being able to game the market or time the market actually doesn't apply here? Because, you know, everyone, I think the majority could recognize the bubble. We all knew that it was going to burst at some point. And then it's a bet on, well, if it's going to exit in six months, most likely, am I willing to take that bet that we won't crash before six months. You know, do you think, can you go about it as such as a retail, secondaries, cowboob? No. That's my quick answer. So I wouldn't try to time the market.

45:08I don't think you can, and I don't think history is good. There are quick slips that work. I mean, Keckner and I watch them go by and it's like, gee, why didn't I do that? That's amazing. But, you know, it's hard to figure out how much of that would look and how much of that was skill. The winner always tells you it was skill. The loser always tells you it was bad luck. I mean, but I'm reminded this timing point that David brought up. I'm reminded that some years ago, Kemper, you and I tried to do a deal together. And it was a beautiful deal. I was super excited about it. I think certain documents were signed.

45:45It was ready to close. And then one of the star assets within the deal exited. and so it was so the deal was off because the seller no longer needed cash but it was an interesting so i don't think you can tie into the market but you can certainly tie the asset and the deal was kind of saying hey this is a great uh portfolio of assets there's one in particular that looks like a skyrocket and it will exit and i'll never forget i was i was driving when the call came in to say uh hey this is bad news the good news is that star exit it really is a star and it just sold at a very high price. And bad news is the secondary deal is off because the seller no longer needs to sell.

46:29So there's a really specific, that was one of many lessons we've learned about timing. When you want to, we always ask a few questions. First of all, is this an asset we'd like to own or own more of? Because I believe in venture, you must buy high quality. The dispersion of returns is very high. So if you buy into something good, you can have a big upside. If you buy into something that's not working, you can lose everything, which is different than private equity secondaries, where they're more banded. The second thing is, okay, if we do want to own more, can we get access to the management and the information?

47:09And maybe we have it already because of the platform effects that Kemper described. Or maybe it's simply that the GP in question is very open and communicative or the company management. So if we would buy direct into a company, we'd always want to talk to the company itself. It would be very hard for us to buy, at least at this point, in arm's length. So we talked to the CEO and we talked to, are you happy with the sale? How does, you know, maybe you're involved, maybe you're not, but you need to approve it, so on. And on the way then, okay, we can get information. Then can we see a time period that makes sense as a secondary transaction and return that makes sense?

47:48And then you negotiate with the seller. That's it. So it is kind of a complicated thing. I don't buy that it's more complicated for retail than the rest of us. I think the difference is the platform advantage that Kemper describes is powerful. And because you know you will have all these information problems, you build the information access in advance. Then you just said the beautiful word, then you negotiate a price. So let's get to that. And I think I actually want to start with the question, which is one of the first questions I asked you, Joe, when we started talking about secondaries. And that was, well, aren't there some rules of thumb that I can kind of, you know, if it's a GP secondaries in year two, then I should get about 20 % discount, blah, blah, blah.

48:36Are there none of those? Or are there some yardsticks that you can kind of use when you go about doing a secondary transaction? section. I'll let whoever of you want to go first. Kemba, you look like you're about to unmute. Yeah, happy to take a stab at that one. I think Joe touched on how he thinks about underwriting earlier. We're very similar. We think about where a company is in its life cycle, when we think it will exit, and what sort of valuation it will garner at exit. That dictates a very narrow band of prices that we can pay today for that company, whether it's a standalone or in a broader portfolio of businesses.

49:20So when we're trying to do a deal with someone, we have potentially some flexibility within that band, but it's typically not a massive range. So I think Joe said a bit earlier, we'll often say to folks, if we don't have pricing alignment, let's revisit in three to six months when we have more visibility into how the company's performing according to its plan for the year or where the broader market is. Yeah, I think there are a number of really interesting structural options that you can use to bridge potential gaps in that sort of bid ask. Those are some of the structural innovations that we've touched on today during the course of the roundtable.

50:08Those aren't always a fit. For the slow-minded here, could you translate structural innovations for me? Not to get too far into the weeds here, but there are secondary deal types where the discount isn't necessarily a relevant metric. For example, if you're investing into a preferred structure where you're basically saying, I'll put X number of dollars against X dollars of value, and I want the first 2X out of the vehicle, the discount there isn't actually something you would think about. So, you know, if you're looking at a deal and you'd say, I'll pay$10 for this asset, that price may not work.

50:59Maybe it's valued at$30 at the last round. But you say, I'm willing to put in$5 against that value, but I want the first 10 back. That may be a little bit more palatable for the counterparty because they're not thinking, you know, hey, I'm selling at a 66 % discount. they're thinking, hey, I've got a fixed cost of capital associated with this deal that has sort of a secondary flavor to it. That's one example. There are a number. But I think, you know, again, I said this a bit earlier, the market has had to be very creative in adapting to the needs of sellers. And I think there's a great cohort of buyers today who've done a really good job of that.

51:42And the market's become very sophisticated in that regard. Now, let me ask a different question. And that is because we had someone asking about if you're building the platform or if you don't have a platform like you do, can you then build that by a relationship building and networking? Is there a sourcing strategy that you can devise as an individual that doesn't have that big portfolio that kind of mimics the dynamic? And Martin, I'll invite you to come in afterwards to tell me a bit about where do secondary platforms fit into this? Because that's, of course, one way to at least get discovery.

52:25Well, you go first. I could take a stab at that one. I'm forcing myself not to get into the structure chat, although that would be really fun with Kemper. Quiet. No, but what can you do? If you think about what assets you might want to buy, we talk about secondary as just a big generic bucket of stuff, but it's not. It's countries and sectors and stages. And so whether you're a big institution or just an individual, thinking about what you might like to own is a good start. And secondly, well, who owns that today? At the end, it's very simple. The secondary, you could only buy something that already exists.

53:14And so if you target that, well, somebody owns it today. So who owns it, right? So if you think about there's some funds in Europe with many, with a long tail of high net worth investors. So one example of a strategy would be, well, let me try to meet those high net worth investors. Maybe I go to the AGM of a fund with that kind of LP based and then make it known during the day, hey, I'd love to buy more. Maybe I'm already an LP, but there's a very simple strategy you can do. And a institutional fund won't buy a small piece, but an individual could. And so everybody with a fund strategy in the same way that a growth fund isn't going to do a 500K chicken in a seed round, right?

53:59Also, a very large secondary fund isn't going to be able to buy a 1 million piece or a 500K piece or a 100K piece. And we do see that. We do buy sometimes where it doesn't even move the needle on our phones, but we do it because we're already there. Only a little bit more is easy. And also being a good partner to some of our PCs means that maybe it's a small deal today and it's a bigger deal tomorrow. So we get those approaches, but hey, I've got a 200J piece and I'm buying a house. Sometimes I call it the cash for houses program. And more times than not with these little pieces that come up, it's so funny.

54:42Oh, why are you selling? Oh, my wife's all this house or whatever's happening. I have a problem over here and I need to get some cash. So I think there are different strategies in the different segments of the market. And buying into that pre-IPO company that Kemper described earlier, that's really a big game. You need a lot of capital. You need a lot of analytics. You need a team like you have. But if you're an angel buying a position from another angel, you've probably been getting quarterly recording on that some time. And so you can understand what you're buying. That's one thought. I'm sure you probably have others.

55:24Yeah. Yeah. I think you already said quite a few things around. There are different segments of the market and different segments can use different approaches actually to gain access to the asset class. And perhaps, hopefully, we can actually play a role in facilitating that and making that a little bit easier. So I think bucketing, for instance, and creating risk buckets is something that is very interesting for pension funds, for instance. They want to gain access, not to one company, but to fintech as a whole, for instance, or AI, etc. And I think a lot of angel investors would also benefit from a more diversified approach towards venture.

56:13Because the lack of large sums of money make it quite risky, actually, to put all your bets on, put them all in one basket. So I think what we are really working on, how do we create liquidity for different players in different mechanisms, bilaterally or centralized? And so when you have the big frontal funds like we have over here, it is much more pinpointed actually towards particular names out there, maybe reverse inquiry. Whereas if you have a pension fund, it will be much more gaining access to a well-diversified group of VCs that disintermediate that through the past many control. So for me, liquidity is not just one place.

57:08It is all sorts of pockets of liquidity. and I think that you gain more, the more you do in this phase, the more transactions you have done, the more exposure you have to different companies. Obviously, you have more data and you become better at it, but that's a good functioning market. So I think that's how healthy financial markets work is that if people are active, they have more data and have a better chance actually of producing certain results. And so I've known to change that mechanism actually in the market. The only thing I would like to do is to find new ways of actually adding liquidity that currently isn't there.

57:50So for me, I looked at the ETF market, for instance, looked at indexation. And again, indexation play a role in this as a liquidity. How do we run certain auction processes to achieve that using technology? And so for me, that's where I'm very interested in starting to explore and run tests in the market for that. Very cool. I just got a question in from someone called Shruti. And her question is, is it advisable, and I'll ping this to you, David, is it advisable for syndicates to consider the secondaries market as a form of exit? And a follow-up question, what are the risks involved in, depending on the stage of investments made?

58:36Very simple question. Maybe I can also reel in. Ari just shared a question like 10 seconds ago saying, would you invest in SPV holding shares of a single company as opposed to direct secondary investments? So SPV is doing secondaries, right? Very similar topic. I think to be honest, I think a lot of it is the same as what Kemper and Joe are kind of already shared in the process that they have themselves, right? So selling, selling, selling secondaries that are in an SPV or selling the whole SPV, whatever, whatever the approach is there. At the end of the day, it's what's the asset or another, like who's the buyer, right?

59:12Who the hell would want to buy this? Because if it's an SPV that is doing small tickets, and then it's only part of that SPV, well, it just connects the difficulty of that deal because who's the buyer? Who the hell is going to buy that? If it's the whole vehicle, well, maybe then, maybe there's something there. But again, who's the buyer and what's the asset? Because Kemper just said common stock being a tough one. That's where most SPVs, I think, are these days. They have common stock, especially the ones that we're seeing popping up everywhere. So can you actually pull off selling that? If you can, well, that's a cool start to the conversation.

59:42If you can, you know, that's them. But what I would say from what we see and the first few deals that we're doing, I think that it all comes down to the motivations of the players within that SPV. So in our specific case, we have INETWARDS and we have families investing with us, right? They have very different motivations. And so would they all want to sell? Because that all leads us to the governance and decision-making in SPVs, which is an incredibly complex and annoying and non-optimized setup in every single kind of SPV I've seen to date almost, right? And so if you can only do majority decision-making, oh, okay, so everyone needs to want to sell, but also everyone needs to agree on the price to sell.

1:00:25Well, if you have 10 guys to agree on that, good luck. I think it's an incredibly hard deal to pull off. In theory, yes, of course, it's a great way to get liquidity. I haven't seen it done myself, but I think that's where platforms can play a role. Some platforms are doing it. And I don't know, Martin, if you have a very specific view to a topic like this. I don't know if this is something that you guys have a worldview on, actually. Yeah, we've created quite a unique SPV, which is different from other VCs. We try to achieve something which is almost like the impossible for the SVG to remain tax transparent, to operate like a trust and then be globally tradable.

1:01:09But, you know, basically meant that Lichten went to work for about a year. And so it works as a depository receipt system. So in that way, you get quite close to the way a common stock would operate. But there are a lot of other SVVs out there. SVVs have been used for ages for different structures, just warehouses. And so, like with any structure, you need to understand the legal repercussions of the structure itself. So it will require quite a lot of work actually for it. So it depends a little bit, you know, what has been put in that. It doesn't grant actually the amount of assets you want to put in there.

1:01:56So that's the complexity of private capital markets. And hopefully, you know, that's how we run everything to the same structure. It's one structure. It is operated to operate globally. Um, and it's designed for this. It's specifically and uniquely designed for this. But yeah, if you want to go structure by structure, yeah, you need experts. It's not easy to do that. And that's something I would recommend. Thanks for my best to jump in doing that. All right. So with this very exciting webinar now being done, and us having given a bunch of cautionary tales about thinking things through, thinking about the complexities that are in secondaries, but also giving some clear guidance on how you might be able to go about it if you're interested in becoming a more active secondaries investor.

1:02:57And also especially a thank you to Flow for building their platform and helping us all get more access to the secondaries markets, as well as to all the VCs that are trying to build more lean operations to run their first, because that is definitely also a hassle and something we could talk for hours on. And I know that everyone in this call would be very queued up to talk about the operational has of running a venture firm. But everyone, thanks so much for tuning in and joining us for this round table. Joe, you've been amazing as always. Let's bring the architect's face up there. That's the guy you want to go to in the middle of the matrix.

1:03:39We've got Kemper here smiling, laughing. He's a happy daddy. Send him a huge congratulations on that role. I want to thank you again our dear friend we are so happy you joined us Martin and David, my dear co-founder thank you for being my best friend and buddy and now I'll just say bye to everyone and thank you all for joining us don't forget to head on over to EU.BC to stay in the loop with everything venture and go to flow.io and keep an eye out for their fund services as well as their secondary marketplace when it comes out live This is a union of values. United and determined we can serve as a model for other regions of the world.

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