LP Unlocked shorts: What We're Hearing about Venture Liquidity with Meghan Reynolds of Altimeter

0:00Welcome to another episode of Venture Unlocked, the podcast that takes you behind the scenes of the business of venture capital. I'm your host, Samir Khaji, and today we have another version of Venture Unlocked Shorts, this time focused on the world of what limited partners are thinking today. Joining me again is Megan Reynolds, who leads Capital Formation at Altimeter Capital. And an area that we've both been hearing a lot about recently is the growing concern LPs have about the generational liquidity within venture capital. As a result, we wanted to have a quick catch-up on this episode on what we are both hearing and seeing in terms of what LPs are saying and the different things GPs are doing about addressing the growing illiquidity concern.

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1:57Allocate or its clients may maintain relationships with or investment positions in guests, third parties, or securities mentioned in this podcast. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Megan, happy Friday. Great to see you again. Great to see you, Samir. Happy Friday. I had a dinner yesterday and I was with a number of different fund managers and we were talking about the fundraise market, what LPs are thinking. And of course, this show is for you and I to talk about what we're hearing from the world of LPs, which has been pretty dynamic over the last couple of years, given the market reset.

2:35And the topic of conversation yesterday was around this notion of liquidity. And of course, we saw in 2021 record amount of liquidity coming back to LPs, whether it was IPOs, M &As, SPACs. And over the last two years, the public markets have repriced. The number of companies going public has decreased pretty dramatically. I think last year, less than$70 billion worth of exits, about 12x down from 2021. And it does appear on a go forward basis, the difficulty and the degree of difficulty to go public is increasingly high. The bar to get to a public offering is really high in terms of revenues and the other fundamentals.

3:18And even M &A might be a little bit tough given what we've seen with things like Figment, Adobe, and maybe the legal deterrent, or at least the FTC and regulatory deterrent. The conversation then turned to, well, if we don't know where the organic ways to generate liquidity are through traditional exits, how should we be thinking about generating liquidity in an asset class that, although historically has always been known for long-term liquidity, it seems like the period is getting longer and longer. I know you and I have chatted about this. You've talked to some LPs, but let's maybe just set the foundation of generating liquidity and what that actually means.

3:57And is this something you're hearing from LPs as well? I am absolutely hearing about liquidity from LPs in nearly every conversation that I'm having. And I think that there are a couple of key questions on LP's minds as it relates to liquidity in their venture portfolios. One is, am I going to be able to fund my next wave of capital calls, given that activity is definitely heating up in venture? We went through the late 2022, 2023 period where activity was relatively slow. The liquidity pressure actually was eased a little bit in the portfolio because there weren't a lot of capital calls coming.

4:37And so the pressure for liquidity comes in this when you have a large portfolio of private assets and you've created a model that suggests you can make new commitments based on liquidity coming off of your pre-existing commitments. The quick question that comes out of this will be, can I fund my next wave of capital calls from my existing portfolio? The next question that I'm hearing is just what is the right timeline for expectations for liquidity in my VC portfolio? Should I think about this as seven to 10 years? Should I think about this as five to seven? We went through a period of time where VC funds were raising funds in a very quick pace, every 18 months to two and a half years.

5:23And that's faster than liquidity comes out. And so I think there was, because that happened at a time that liquidity was coming out very quickly, people revised their expectations to say, I can fund new commitments in a expecting a shorter duration of my investments. But I think everybody's resetting that model now and thinking through, you know, what are the more reasonable expectations? expectations. The third question that I hear a lot is when I invest in a GP and I have a position that goes public, how should I think about when you exit that position? Because I think we saw a lot of varying behaviors during kind of the peak, the market peak, and even still today.

6:07So is that consistent with the questions that you're hearing in your conversations? It very much is, and for a number of reasons. So you pointed out something I think a lot of people have discussed in the LP world, which is 19, 20, and 21, funds are coming back very quickly. And capital was drawn very, very quickly. It wouldn't be surprising for me to see a fund being 50 % called within 18 months of actually starting and activating the fund, which historically, if you go back 10, 20 years, the time period between funds was three to four years. Then it contracted to 18 months, 24 months, and sometimes even 12 months, believe it or not.

6:46And so when you had that, it was working because in 2021, we had so much liquidity come back. A lot of people made commitments in 21, 22, 23, the liquidity faucet turned off. And now people are looking at and saying, well, I need to think about my new commitments. How do I fund those capital calls? but they also want to stay in the market. And the big question is, well, if organic liquidity is not going to happen at the pace that we would have hoped, is there a way for managers to think carefully about generating liquidity? The generation of liquidity, I mean, if you look at it historically, a lot of times it's been LP led and LP raises their hand to a GP and says, I need to get liquidity.

7:30Either that liquidity is because they want to rebalance their portfolio or because they just need liquidity to pay new capital calls or if it's a family office, other things that they may need the liquidity for. The efficiency of an LP transfer is, I mean, it's really, really low. We've seen certain things in GPs. Think about different ways to generate liquidity. I mean, the most common, of course, is you have the ability to sell in a secondary. I saw plenty of those opportunities in 21 and many people should have done it. And there should have been some kind of methodology of if you're a GP, when do you sell?

8:06How much do you sell in those later stages? And ultimately, do you now view some of the later stage big bulge bracket funds as liquidity partners for you? And that was the question that came up yesterday. They said, okay, well, in private equity, this happens all the time. You have lower middle market PE selling their companies to bigger PE firms. And that's a very common thought of, well, there might be a different buying universe. So curious if you've heard anything from LPs thinking, well, are they asking the questions to the GPs of what is your liquidity management structure and protocol when you are offered a secondary sell through a tender?

8:49That is a big question, especially when there's a large embedded gain in a position, I think there's this question or debate in LP's minds and GP's minds of say, if I'm in an investment early, I now have a huge embedded gain, and I may be seven to eight years into this investment, somebody's offering to buy this position at what I think is attractive. but I also think there's runway from here in terms of additional return. As a fiduciary, how should I think about that? What is in the best interest of my LPs? Is it actually to return some liquidity, send some of my basis back, or is it to optimize the return on that investment?

9:37And I think it's really challenging because if you are actually to ask your LPs, you'll get different answers from different stakeholders. Some people that said, yeah, it's reasonable to send your basis back. Take at least your basis back and keep some basis in and maximize the upside with the rest. Others that would say just purely, I don't care about liquidity now. I'd rather get maximum return, particularly if this is one of your high-performing power law assets. And this is the conundrum that GPs face. And I think having a dialogue with LPs, your LPs on this is really helpful and healthy. Having some level of transparency on your thought process and asking for feedback so you actually understand the wishes of your stakeholders and whether or not there is some consistent desire from your LP base is really helpful.

10:29But it is, I think that's an active consideration that we're particularly facing now, given there is a lack of liquidity in the broader industry. I don't think it's a question when you've got cash coming from other pieces of your private portfolio, but it is the case now. It is a hard thing to balance. And there's not a perfect answer, I don't think, in terms of when to decide to sell. And I do think some of the things that used to persist were a seed stage manager would say, well, if I sell in the Series C or Series D, is there a signaling effect? I don't think that exists. I think at that point, you're largely of lower relevance to the ultimate founder.

11:11And even selling a piece of it is not going to create any type of negative signal. It's just a transfer of interest from you to maybe somebody that's a later stage investor who, by the way, the founder may want to have more ownership in their company because it's more aligned with where they are as a company. and I've seen people do different things. I think the thing that we hear often is that even though there's not a perfect answer, we just want to understand what the methodology is that the GP is going to do. What is that internal calculus of if we sell, this is how much of our stake we typically sell along the way.

11:47And what is that meaningful return that it has to drive for us to even be interested in doing the sell versus waiting? And so when you have so many different LPs that have different priorities and different models, you're not going to create a perfect model for each one of them. But I do think it's really important for GPs to have some kind of methodology of when do I sell? What does it have to return to the fund? And in what cases do I want to actually hold the asset longer? And those are really, really tough things. But we're seeing some big firms do this. And of course, we've seen people like UnionScore Ventures and others, be very active and thoughtful in when to sell in secondaries.

12:28The other thing that I think you and I have seen a little bit is not just a normal, I will sell during a secondary tender for a traditional round the company is doing, but this concept of strip sales. And strip sales historically had been done a lot in private equity. And in venture, we've seen a couple of these examples recently. Maybe you can talk through the two examples that you and I talked about and just maybe first define what is a strip sale? A strip sale is when a GP decides to sell a portion of the assets in a portfolio to a secondary buyer. So there's lots of secondary funds out there, some very large and very well known.

13:13You could talk about, you know, this is the Goldman Sachs Vintage Funds or Lexington Partners or Stepstone has a big practice, HarborFed, like there's a lot of funds that are out there that buy both individual fund positions, but also portfolios of interest from GPs. These are called GP-led secondaries. And a strip sale is when they'll come and they'll say, the secondary buyer will come and say, I'm going to buy 10 % of your entire portfolio or 20 % of your entire portfolio of assets. So literally just returning part of the basis back in your entire fund. They could also strip out strip out certain assets and say, I'm going to buy six assets as a portfolio from this fund, and LPs are getting back the profits, depending on where it's marked, in those six assets.

14:02So there's a lot of different ways to structure it. We've seen a couple of interesting case studies recently, as you mentioned. One that was very well written about in the press was a transaction that was done with a group called Primary Ventures. They had a fund that was a 2015 vintage. So this is eight or nine years into the fund. They were very well into the money on this fund. And the secondary buyer bought 30 % of the value of the fund and they were able to return that value directly to LPs. And I think in this case, I believe Stepstone was the buyer. It was interesting to me because there was a comment from the GP in this case that said, my job is to deliver liquidity to LPs in 10 to 12 years, but it's going to take five years to generate a lot more liquidity.

14:55And that will be fine for this new secondary, for Stepstone, who's stepping in and buying these assets. But I've got to get the capital back to some capital back to my LPs. And it's interesting to make that, for the fiduciary to be making that comment. Like it is part of my job to get this done in 10 to 12 years versus I think the general mindset historically in VC was it's going to take what it's going to take and we just got to let it ride. And the timeline is the timeline. Yes, these partnerships were structured as 10 plus two year timelines, but average funds last way longer than that. And that's just what you get when you invest in the asset class.

15:33But in this case, I think it's a changing mindset of GPs of, I actually have a timeline that I need to reach and that there are these secondary providers out there that will help me deliver that back. Now, in this case, the fund was very much in the money. It was a six and a half times multiple TVPI fund. So they were able to get a lot of value back. It wasn't a distress to sale by any means. It was a way to get some real DPI back. It will be very interesting to see if you've got a lot of other, if there's in the money funds that are aged, because we know there's a lot of embedded, undistributed value in the industry.

16:12If we start seeing these large secondary funds really provide solutions there in additional case studies. I was talking to an LP, which this LP has a very long time horizon, meaning that they don't really need to generate liquidity constantly. They have 10, 20, 30-year horizons. They've invested in venture for two decades. And what she said to me was that we're fine with the maximization of the overall return of the fund. But at the same time, from a liquidity standpoint, as that liquidity window continues to lengthen because companies are staying private longer, probably more so now, because I think in today's world, you have to be more efficient.

16:53It's not just growth at all costs. And to get to those numbers, to get through an IPO or a M &A will take longer and longer and longer, especially with so much late-stage capital available even after the departure of some of the, let's call it the tourist capital. But what she said is, from a DPI standpoint, I look at net IR and I look at what has actually been returned to me, in private equity, I can get X. And historically, venture has been an area where I'm looking to get, in her eyes, 500 to 700 basis points more than what she would get in PE. But if the liquidity window gets longer and longer and longer, well, the realized part of the IR equation just actually goes down and down and down because it takes so long.

17:39And so her view was, I have to make the case of venture versus private equity. And part of the questions we ask managers is what is liquidity management for you? So it's not just evaluating the manager in terms of picking, winning, and sourcing deals, but it's how are you thinking about managing the portfolio as a fiduciary to make sure you're giving me the type of return that makes up for this longer liquidity cycle that we're likely to see. And it was a pretty interesting conversation. So things like primary are a good example of taking money off the table for your LPs in a meaningful way, but yet still retaining some of the upside.

18:18There was another one I think that came up, which is a group 11. And I believe that was also Step Zone and maybe industry was involved in that one. But let's also talk about that example. And maybe this is something that we just see more of. And it's not just this outlier or anecdote, but it's part of a longer term trend we're going to see. Yeah. In this case, and I don't know the full ins and outs on the transaction, but the GP, which is Group 11, again, a 2015 vintage fund. So we're talking about eight or nine years into its life, did a deal with, I think, Stepstone Industry Ventures that allowed LPs to realize either their positions either entirely or partially.

19:05So it sounded like there was some sort of opt-in or tender process involved that allowed participating investors to get a 3x cash on cash return and a 20 % IRR in eight years. You know, I think for a lot of LPs, that's hitting a bullseye. If you're an institutional LP and you're saying, okay, I can get a 3X and 20 % IRR in eight years, I've hit a threshold, and that is success check. and whether I see, you know, I have some questions about how long it's going to take from here or how much upside exists, you know, that will be the individual consideration of each LP. But I think it's another interesting case study of, you know, ways that a secondary funds were able to manufacture a return profile that I think a lot of LPs would desire if they could tie it up in a bow and achieve that outcome?

20:03It's definitely something that we are hearing much more for sure. And every single LP conversation I have now is how do we think about liquidity? What is the cap call cadence that's going to happen? How long will they call capital over, which typically for a venture fund is three to five years. But when should I expect my first dollar back? And if you actually look at the benchmarks, you can look at PitchBook with Cambridge. 2015 DPI is not very good. This is despite 2021 being one of the big watershed years in terms of liquidity. So a lot of people now are viewing it under the different lens.

20:38And I would just say that for any GP that's listening, whether you have a completely formulaic strategy or not, it's something that you should be thinking about as an avenue to build trust with your LPs and know that portfolio management, liquidity management is absolutely part of the business. I think in the next three to five years, we're going to see a lot more of this. We haven't seen continuation funds that much within the VC world, certainly in private equity, we've seen plenty. NEA did a big one, I think, several years ago, where they spun out a firm called NewView, which basically took about a billion dollars worth of stakes across, I don't know if it was one firm or multiple funds, it's all public knowledge.

21:21That was a huge thing for a very big firm. Our view is that we will see much more of this. Venture is going mainstream and some of the influence from other asset classes will start to permeate within the venture lens. So I want to end with that comment and see if you agree. And I guess just you sit in this really interesting seat because you talk to so many LPs every day, so many GPs. Is your assessment that the world of secondaries or the world of liquidity and liquidity management is going to now progress to this next level within venture? I think it will. I think it will continue to evolve.

21:58I think in so many ways, and I've written about this and I talked about this, I think venture will ultimately evolve and institutionalize in ways that buyout evolved and institutionalized in 2008 to 2010, 11, 12, post-GFC when buyout went through a very difficult fundraising period. and it forced to be more transparent, more LP friendly, be more creative in how it delivered solutions. And all of that was driven by buyout funds needing having a hard time raising capital. We're going through a period where a lot of VC funds, most VC funds are having trouble raising the capital that they want to raise on the timeline in which they want to raise it.

22:50And it is that pressure and the pressure to raise that will make you reconsider how you're interacting with your LPs. And I think a lot of GPs, VC funds right now are hearing, I can't commit to your next fund until I see some results back in my pocket. Like until I have some cash on cash returns, because I've been in this partnership with you now for several funds, I have to see some results. And it is that pressure of I won't be able to raise until I return some BPI that will make GPs really get more creative and start to think about ways that they can deliver that cash to LPs outside of the traditional exit path.

23:37It's a tricky balance too, because you don't want GPs to generate liquidity for the sake of liquidity, just to be able to raise additional capital, particularly if it comes at the expense long term of the past, because it goes back to that fiduciary responsibility. and you're right. I think the time for fundraising has been really stressed over the last two years and many funds have now doubled the time budgeted for raising a fund. Even really good firms, really good firms that have long track records, the type of questions and the specter of liquidity is a big one. This has been a lot of fun.

24:16I always like having the conversations with you because you have your ear to the ground with what institutional and non-institutional LPs we do the same. And it's really just fun talking about what we're hearing in the market. And I think liquidity is a big one. So thanks again, Megan, for coming on. So fun to chat, Samir. Happy to do at any time. Thanks so much for listening to another episode of Venture Unlocked. We really hope you enjoyed it. To learn more about Megan, be sure to go to Venture Unlocked Substack at VentureUnlocked.substack.com, where you'll find detailed notes of the show and a listing of past episodes.

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