The last three quarters have been rough for VC. Very rough.
Are corporate venture arms heading for the door?
And if so, what’s behind door number 2?
Door number 1 was seeking strategic insights. For many, it’s been a successful strategy. Intel and Google, among others, have generated outstanding strategic and financial returns, year in and year out.
For other CVCs, it may be time for door number 2: exit or re-set.
CVC has traditionally gone in cycles: A seminal market-lifting event causes CVCs to rush in. A seminal market-deflating event causes many CVCs to rush back out. The previous cycle was kicked off by the Netscape IPO and the late 1990s dot.com boom, and peaked when Bertelsmann AG pledged $1B to its CVC – which exceeded the size of total CVC investment at the height of the previous wave. And it deflated when the dot.com bubble popped. CVCs wrote down $9.5B of venture losses in Q2 2001 alone.
We’ve now been in a bull market for CVC for over 20 years. CVC dollar volume is up tenfold since 2001, a “bananas” level of growth by some accounts. And despite a recent slowdown, CVCs still accounted for 21% of all funding in 1H 2023, holding steady as a proportion of total VC investment; though 2023 CVC volume is on pace to drop 30% YoY.
But a high interest rate environment, systemic shocks from geopolitical instability, and the collapse of SVB may be driving the end of the cycle.
TotalEnergies Ventures, Microsoft’s M12 Ventures and Verizon, among many others, are paring down their portfolios.
Should CVCs hunker down and work to turn things around in their portfolios?
Or should they head for the exits?
Many of the CVCs we work with are doing neither.
They don’t want a waste a good crisis. They’re using this moment to reset their portfolios; remove non-strategic assets; refocus their priorities; and free up dry powder to redeploy capital (at newly attractive valuations) in more strategic businesses, by selling down some positions.
What will they likely to face in the secondary markets?
The secondary market is roaring
VCs are under growing pressure to deliver DPI (distributions relative to paid-in capital). Capital calls are now outpacing distributions. Institutional investors are motivated to reset their portfolios by the denominator effect. 68% of institutional investors are concerned that rising interest rates have made their existing VC investments less attractive.
That’s driving roaring secondary markets. 2022 secondary volume was $108 billion, the second biggest year on record, and the ratio of available capital to LTM volume (capital overhang multiple) increased to 2.1x by the end of 2022. Industry Ventures, Pinegrove and StepStone are in market for new VC-focused funds of up to $2.6 billion, and reportedly are generating 27% to 29% IRRs on their existing VC-focused funds.
Evercore Private Capital Advisory reports that today, there’s $139 billion of dry powder for secondaries, an all-time high, and up 6% just since the end of 2022.
But as Evercore notes, volume of closed deals is down – secondary market volumes remained robust in H1 2023 were $42 billion versus $54 billion in H1 2022 (and $48 billion H1 2021). Translation: Buyers have a lot of money. But they’re becoming more selective.
And bid ask spreads are narrowing. But they’re still hefty. They were a skinny 7% in early 2022 when VC markets hadn’t yet been dislocated. But they tripled by August 2022 as sellers were slow to adjust to new market realities and remained anchored to 2021 valuations. By year end, the spread had dropped more than 30% from the August highs as seller pricing expectations came to earth. Today the bid/ask spread is 22% reflecting a closer alignment between buyers and sellers.
What about pricing?
Sorry you asked. VC remains a small overall proportion of secondaries. VC and growth equity combined, declined from 18% of total secondary volume in 1H 2021; to 12% in 1H 2022; and was just 7% in 1H 2023. (LBO by comparison was 76% of secondary volume.) That small proportion of VC deals and that selectivity by buyers has shown up in heavy, though improving discounts.
LBO discounts went from 97% to 87% in 2022. VC pricing on the other hand, declined last year by 2,000 basis points, from 88% to 68%; with the NASDAQ down 33% in 2022, buyers had little confidence in relative asset values and showed limited demand for even the highest-quality GPs without 30%+ discounts. There were shrill headlines about even deeper VC discounts in Europe.
Some players are predicting discounts will get smaller this year.
But even with discounts that aren’t pretty, as we’ve described in fancy presentations presentations and written here and here, there are enormous strategic benefits for CVCs in acting decisively to turn around their investments, or pare back their holdings. Hunkering down and hoping for discounts to narrow or valuations to recover, can create enormous opportunity costs. That’s both from being distracted by managing holdings that are non-core or have become challenged; and in failing to make new, more strategically-aligned investments in an investor-friendly environment.
That’s what we do.
If an initial consultation to see if a no-cost Insights Process to review your options could be useful, just let us know.