VC Secondary Market Partner Perspectives: Ted Clark

In this third release in a series of interviews with successful figures in the secondary market, Derek Minno talks with Ted Clark , co-founder and partner at FourBridge Partners , about the Venture Capital secondary market and its history. This article features Derek's takeaways from the conversation along with his own insights, as written by Derek himself.

Story Voices

Derek Minno (interviewer and author) —Derek has served as a GP in a domestic VC Fund; a GP in an international PE Fund, a LP in multiple PE and VC Funds, and a C-level executive in VC backed companies. He is the President of Point Capital .

Ted Clark (interviewee) — Ted was an early member of the team at Hancock Ventures (now HarbourVest ), one of the original institutional investors in VC/PE secondaries in the late 1980s. Ted is now a co-founder and partner at FourBridge Partners .

Before jumping in, a note from the author:?

"This collection of conversations features insightful interviews with successful figures in the venture capital secondary market. Discussions are focused on the perspective of opportunity analysis, historical evolution, and the current as well as future market trends and activities. The participants of these interviews offer insights and contribute diverse perspectives. We will summarize the interviews and provide both key information and wisdom honed from experience."??

VC Secondary Market Partner Perspectives: Ted Clark

Ted describes the Venture Capital Secondary business from the perspective of an Institutional Investor.

History of VC Secondaries

• In the late 1980s, there were a few one-off secondary transactions, but they were opportunistic and infrequent.
• By the early 1990s, the market began to evolve and become more regular. Initially, sellers were often corporate or strategic investors with underperforming venture and technology programs.
• Deals in the early days typically involved fund commitments ranging from $2 million to $10 million, and they were viewed as add-ons to the primary fund investment business.
• Hancock Venture Partners (now HarbourVest) played a significant role by creating the first dedicated fund for venture capital secondaries around 1992, named Dover Street. This marked the beginning of a more organized approach to secondary investments.
• The venture capital secondary market gained momentum in the early 2000s, particularly after the bursting of the internet bubble. This was driven by two main factors:

1. Many individual investors, especially in venture capital, found it challenging to meet their capital calls, highlighting the risks they had taken.
2. Institutional investors, including Harvard Management , turned to the secondary market to rebalance their portfolios due to the denominator effect and imbalances between venture, buyout, and growth investments.

• In the 2000s, the secondary market transformed into a fund management tool that allowed investors to manage their fund relationships, exposures, and skip the J-curve. Firms like HarbourVest recognized the potential of the secondary market as a business, leading to the creation of multi-billion-dollar funds. This shift also saw a greater focus on internal rate of return (IRR) as a key performance indicator and innovative deal structuring.
• As venture capital fundraising took off in the 1990s, and approximately 5% of limited partner (LP) commitments began to change hands, secondary capital fundraising also saw significant growth in the 2000s. This expansion was not limited to venture capital but also extended to buyout and private equity markets, making it clear that the secondary market was becoming a substantial and vital component of the investment landscape.

Analysis

Venture capital secondaries can be a low-risk strategy when executed correctly. This is primarily due to the diversification of portfolios. For instance, programs like Dover (HarbourVest) have hundreds of partnerships and possibly thousands of companies in their portfolios. Diversification allows for risk mitigation.

Key points about why venture capital secondaries can be low risk:

1. Diversification: Large venture capital portfolios can include hundreds or thousands of companies. This diversification helps spread risk.
2. Portfolio Knowledge: Investors in these portfolios often have in-depth knowledge of the companies they are already invested in. This familiarity allows for better risk management.
3. Moderate Leverage: Investors may use moderate leverage to enhance returns while maintaining a risk-appropriate profile.
4. Efficient Pricing: Structuring deals with efficient pricing benefits both sellers and buyers, allowing sellers to obtain a good price while buyers can participate in the upside.
5. Performance: Typical performance metrics for these assets include a return of 1.5X and an internal rate of return (IRR) ranging from 10% to 20%, depending on timing.

In contrast, buyout portfolios are generally smaller, often consisting of 10 to 20 companies. While they may be easier to evaluate, this can introduce complexity, particularly in terms of deal structuring, especially from the standpoint of leverage and dealing with sellers.

Market View

Ted discusses the competitive landscape in the venture capital market, changing return expectations, the growth of the secondary market, and potential concerns regarding SPVs and co-investing, as well as the influence of fund size on performance.

1. Capital Availability: Despite a recent decline in capital, there is still a substantial amount of capital available, either raised or committed, within the market. This capital is being sought after by various large funds, which are aiming to raise significant amounts, typically $10 billion - $12 billion.
2. Increased Competition: The venture capital market has become more competitive than ever. Large funds are actively raising capital and seeking opportunities. This competitiveness is partially driven by the need for investors who have committed substantial amounts and need to rebalance their portfolios.
3. Changing Return Expectations: It is anticipated that return targets in the venture capital market will come down in the future. Instead of the previous goal of achieving 1.5 times the initial investment, the new target might be 1.3 or 1.4 times the investment. However, with managed liquidity and access to lines of credit, these investments could potentially target a 10%-12% internal rate of return (IRR), seeking to provide a premium compared to public markets.
4. Growth of the Secondary Market: The secondary market for venture capital has seen significant growth. This growth has been fueled by the opportunity for companies that have delayed initial public offerings (IPOs) to secure additional private financing.
5. Concerns About SPV or Co-Investing from LPs: There is a looming concern related to special purpose vehicles (SPVs) or co-investing by limited partners (LPs). This could be a disaster waiting to happen.
6. ?Impact of Fund Size: The size of venture capital funds has grown significantly over the last decade. Many firms have raised billions of dollars of capital and expanded into multi-product, multi-platform, and multi-stage investments. The increased fund size can impact performance and larger venture firms might face challenges related to their performance and returns.

Key Interview Quotes

“If done correctly, secondaries are an incredibly low risk strategy.”

“Even though we've had a falloff in capital, the markets are adjusting, there's still a lot of capital out there. Either raised or committed. I think that the need will be there.”

“I'm not sure anybody would have predicted the growth of the secondary market. The funding opportunity for companies that delayed an IPO created a need for increase private financing and that assisted the growth for secondaries.”

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Disclaimer: The information presented in this post is the sole opinion of the writer and does not reflect the view of any other person or entity. The information provided is believed to be from reliable sources but no liability is accepted for any inaccuracies. This is for information purposes and should not be construed as an investment recommendation.