Venture Capital's New Reality: Dehorning Unicorns and the Surge in Secondaries

Nowadays, increasingly more minority shareholders such as private and angel investors, funds, and startups’ current and former employees seek liquidity events for themselves by selling parts of their shares in companies. In the next 12 to 18 months, this can lead to an increase in the number of transactions in the secondary venture market. Historically underemphasized, secondary markets have recently come into the spotlight, particularly with the increasing volume of direct secondaries. As we look into the next one to two years, a rapid surge in GP- and LP-led secondaries is anticipated. This uptick is partly fuelled by the deflation of the late-stage VC market, a consequence of the bubble burst in 2022 following the high-flying period of 2020-2021. The stark "dehorning" of large startups with valuations above $1 billion is unmistakable, with late-stage valuations plummeting by 50% to 80%. According to Forge Global, an alternative trading venue operator, 90% of researched private companies with a unicorn status in 2021 are now valued lower in the secondary trades, and a third of them have lost this status entirely. Interestingly, AI companies are carving a distinct path in this landscape. Their valuations do not correlate with the broader venture market, and they are able to raise billions of dollars. Their emergence is pressuring traditional SaaS companies, potentially rendering some obsolete and out of business.

The venture capital landscape is witnessing profound changes. The hold period for VC funds is likely to extend, influenced by investors' reluctance to sell assets at real prices which in many cases mean - at a discount. Amidst these trends, notable players like Softbank and Tiger Global have significantly reduced their activity, impacting unicorn fundraising. The IPO window, stifled by macroeconomic conditions, is expected to stay shut until interest rates decrease. Consequently, many pre-IPO companies are postponing their public debut, awaiting a more favorable macroeconomic climate. This scenario paves the way for more buyout opportunities for other shareholders seeking de-risking or cash-out options.  However, the clock is ticking; by the end of 2024-25, startups will need to make a pivotal choice - IPO or face failure. In this "VC winter," only startups with robust, efficient business models and resilient founders are likely to weather the storm.

As of November 2023, the global landscape boasts over 1,200 unicorns, albeit at outdated valuations. The surge in global mega-rounds in 2021, jumping to 1556 deals from 630 in 2020, indicates a wide range of opportunities in large companies. Employees, eager to realize gains and partake in their company's success, are increasingly interested in selling their shares, prompting companies to offer special liquidity programs. In such circumstances, investors must diligently assess startups' fundamentals to ensure their viability and growth potential. Although, the IPO market started to show promising signs in the end of 2023, investor appetite is still gravitating from growth to value amid tightening liquidity. Moreover, the M&A route is becoming more complex for startups, given the broader impacts of the macro environment on large corporations. The current period, albeit challenging, presents golden opportunities for seasoned investors through significant discounts and reduced competition. It's a transformative era, potentially establishing secondary VC transactions as a vital segment of the venture market. Investors with extensive networks stand to gain substantially from the burgeoning secondaries deal flow.

New market entrants such as private investors, family offices and others can fill in the lack of liquidity in traditional public markets and scarcity of M&A opportunities. The new investors in secondaries are attracted to lower risks compared to early-stage startups and discounted prices which can still provide high annual returns outperforming the broader stock market. The profile of the new entrants is different compared to “hype investors” of 2021-2022. They are much more interested in fundamentals and conduct extensive due diligence to ensure that the companies are efficient, cash generative and well-managed. 

The common investors’ concern about the lack of data and transparency in private secondary markets is also being addressed. A highly technological trading platform of Nasdaq Private Markets is gaining momentum, giving investors access to previously hidden opportunities and information. Other brokers such Forge and CartaX are also attracting attention of the ones seeking quality deal flow. The convenience of such platforms is set to drive the secondary markets further.

The venture capital landscape is undergoing a pivotal transformation, influenced by evolving market conditions, investor behavior, and the disruptive impact of AI. Secondaries are set to become a new and important sphere of interest for investors looking for quality, lower-risk opportunities in tech industries. As the sector navigates through these turbulent times, insightful investors and resilient startups are poised to emerge stronger, reshaping the future of venture capital. The next three years will be crucial for the overall venture capital and startup industry and will determine its vector of development for years to come.