IPOs slow? Invent your own private stock market!

I have written, a few times now, about how a slowdown in private equity exits has been putting pressure on funds that need to return capital to their investors, with some funds now loading their companies with debt to help pay for dividends to distribute cash. Venture capital has been facing a similar bottleneck. A sluggish IPO market and a growing number of companies staying private has made it more difficult for VC funds to exit positions and return capital to their investors. But now, some venture funds are providing a solution to the problem by offering to buy shares from other investors at a discount. From The Financial Times:

The venture capital group G Squared has raised $1.1bn for its latest fund to capitalise on growing investor demand for its strategy of buying pre-existing stakes in start-ups.

Founded in 2011 and based in Chicago, G Squared has backed technology groups such as artificial intelligence company Anthropic and cyber security specialist Wiz.

While typical venture capitalists focus on buying new shares in start-ups, G Squared invests most of its funds in existing shares, bought directly from start-up employees and investors who want to sell some of their holdings.

Larry Aschebrook, the founder and managing partner of G Squared, also told the Financial Times that “investors can buy shares in the secondary market at about a 30 per cent discount to company’s value, and at a 70 per cent to 80 per cent discount to the prices investors paid during the low interest rate-fuelled boom times of the coronavirus pandemic.”

In public markets, the price you see is typically the price you get, unless you’re buying or selling a multi-million dollar position. If Apple is trading at $230 per share and you want to buy Apple’s stock, you’re going to pay $230. Tens of millions of Apple shares trade hands each day, and they are easy to buy and sell.

In the private markets, however, the price you get is what someone is willing to pay. And the cost of liquidity is, according to Aschebrook, a ~30% discount to the company’s value. It’s honestly a genius move by G Squared. Venture funds typically have ~10 years to return capital to investors. A fund approaching the end of its life cycle with a lot of capital still tied up in private companies needs to sell, and there aren’t too many buyers in the secondary market for venture shares, so G Squared can effectively name their price. If, for example, there was a hot startup that was last valued at $5 billion, and it has a good chance of exiting via IPO or acquisition in the next few years, but some of its investors need capital, G Squared can now go in and say, “Hey, we’ll buy your stake at a $3.5 billion valuation,” and they have another ~10 years before they have to sell.

Basically, they’ve created their own stock market for private companies where they are one of the only buyers, and when you’re the only buyer in a market of desperate sellers, you can set the price. I suspect we’ll see more of these “secondary” funds emerge over the next couple of years.