Second to none: Why now is the perfect time to invest in the secondary market

No one can deny that the economy is going through an extended downturn right now – making this an ideal opportunity to look at discounted secondary deals

Let’s face it: the venture capital ecosystems of the USA and Europe, particularly their respective tech sectors, have hardly been booming for the last six months. There are macroeconomic reasons for this, of course. The war in Ukraine, for example, has led to severe inflation and increased interest rates from mid-2022 through 2023, whereas the glut of cash injected into the global economy during the Covid-19 pandemic (which itself contributed to that same inflation) meant that 2021 was a boom year for tech-focused investing. As such, a correction was always on the cards, and it has arrived. Encapsulated best, perhaps, by the five “MAGMA” tech giants – Meta, Amazon, Google, Microsoft and Apple – shedding staff by the tens of thousands, this market correction has also seen decreasing valuations in biotech and Web3 companies, as well as many other areas within the sector, and a near-total freeze on tech IPOs.

Everyone knows that downturns are inevitable within the economic cycle. That’s nothing new. What isn’t universally recognised, however, is that the ongoing reset can be regarded as ultimately good – however painful initially. From change and uncertainty can bloom some of the most promising new ideas and companies, including those that might define the next decade.

Case in point: several members of the NJF Capital team experienced the moment the 2000 tech bubble burst, and even more of us were working during the post-2008 recession. That meant we also witnessed first-hand the opportunities that such disruption can bring. Many of the world’s largest unicorn companies started operations in the immediate aftermath of a major downturn, including SpaceX (2002), Facebook (2003), LinkedIn (2003) following the first dotcom bubble, and Uber (2009), WhatsApp (2009), Slack (2009), and Instagram (2010) after and during the Great Recession.

Whether the current choppy waters in which tech finds itself develop into a more major crisis remains to be seen, not least in the context of a potential banking sector failure sparked by the collapse of Silicon Valley Bank, but a silver lining to this situation might come in the form of secondaries. There’s a gulf in valuations between primary and secondary opportunities, meaning shares in some companies with significant potential can be acquired at a discount by those with the right access.

Secondaries, in general, are good for various reasons. They give access to companies that have by definition already matured beyond the early stages of start-up, and which may have established revenue streams and proven business models. They can help diversify a portfolio and the market is more liquid than the early-stage start-up market. And, of course, there tends to be more transparency around the health of the company in question – something that might feel important to investors following the high-profile fallout from the lack of due diligence carried out on FTX before its collapse late last year.

Private equity (PE) has always had an interest in secondaries. The industry has its roots in the 1960s but it was really the 1980s when it began to boom – Bain Capital, Blackstone and Carlyle were all founded between 1984-1987, for example – and with it, the PE secondary market grew rapidly too. Coller Capital was founded in 1989 as the first European secondaries firm specializing in the purchase of existing private equity interests. By 2011, the PE secondary market saw $24 billion’s worth of transactions take place, 10 times the volume for the previous decade, and by 2021, that figure had more than quintupled to pass $130 billion.

Venture capital (VC) is playing catch up on the secondaries market, largely because the industry has only seen growth similar to that of PE in the past 20 years, rather than the past 40 – put simply, VC is a younger business phenomenon. However, given the growth of the asset class within primaries over the last decade, the VC secondary market certainly has the potential to grow to the same size. Industry Ventures, a San Francisco-based VC firm that invests in late-stage venture-backed companies on the secondary market, predicts that the VC secondary market could surpass $130 billion this year.

There’s another trend that makes secondary access important in a way it hasn’t been, necessarily, until recent years. That is the fact that, in 2023, exceptional companies stay private longer.

In parallel to the post-recession downturn, another phenomenon occurred, fuelled by the emergence of venture capital: the average age of a private company at the point of IPO rose from three years in 2000 to 10 years in 2018, whilst the average capital investment also increased dramatically. Today, the average tech company takes 12 years to IPO. Apple, founded in 1980, floated in 1984, for example; by comparison Airbnb, founded in 2008, floated in 2020. Amazon was founded in 1997 and floated in 2000; Uber was founded in 2009 and went public a decade later. For VCs operating in the primary market on traditional ten-year cycles, this makes it harder to deliver returns to their LPs, as the exit strategy of IPO is less common.

Nowadays, to access these sorts of blue-chip companies, investors need to invest in the private market – they simply aren’t targeting IPOs as a priority. Couple that with a more risk-averse venture capital landscape, and it’s not hard to see why investors who were well placed to acquire secondaries would do so.

So how to decide which secondaries are worth looking at? NJF Capital has a pipeline monitoring the 529 B2B unicorns in the world, out of approximately 1,200 total, with a particular emphasis on those at Series C to F rounds of fundraising – some 283 in total. And of these, NJF believes that approximately 15 companies are particularly appealing within the secondary market, comprising 12 in the USA and 3 in the EU. The criteria for attractiveness for different investors will vary, but one thing is for certain: the opportunities within secondaries are many, and healthy.