If you ask investors to name the biggest challenge for venture capital today, you’ll likely get a near-unanimous answer: lack of liquidity.
Despite investing in startups or VC funds that increased in value, due to the dearth of IPOs, those bets are not generating much, if any, cash for their backers. That’s the drawback of private investment versus the public market. Shares of companies in private companies like startups cannot be sold at will. The companies must authorize their existing investors to sell their shares to approved others, known as secondary sales.
Cash-hungry venture investors, whether VCs themselves or their limited partners, are increasingly looking to sell their illiquid positions to secondary buyers.
Now, add in that many early-stage startups were overvalued during the fundraising frenzy that peaked in 2021 and that those shares may now be worth less. That presents a new and unique opportunity to buy stakes in seed-stage VC funds, as well as shares in startups, at relative bargains.
Today, Cendana Capital, a fund of funds that invests in dozens of seed-stage venture firms, and partner Kline Hill Partners, a firm focused on buying small previously owned private assets, are announcing a new $105 million Kline Hill Cendana Partners fund, which is well above the $75 million target they initially hoped to raise.
“Over the past two years, we’ve been hearing from our portfolio funds, ‘We have a family office that wants to sell their $2 million commitment. Would you be interested in buying it?’” said Michael Kim, founder and managing director of Cendana Capital.
Kim felt the opportunity to increase his firm’s ownership in venture funds and promising startups at a substantial discount was too good to pass up. But, since investing in secondary assets requires expertise that none of Cendana’s investors had, he decided to join forces with Kline Hill.
Raising money for this fund was easy, Kim said. Cendana’s limited partners were asking Kim to take advantage of this buyer’s market.
“We simply passed the hat around to our existing LPs at Kline Hill and Cendana,” said Kim.
Buying stakes in seed funds
What sets Kline Hill/Cendana’s investing vehicle apart is that it’s buying secondary interest in seed-stage firms and individual companies from seed funds. Most existing secondary players are too large to go after this opportunity, according to Kim.
It’s hard not to see the symbiosis between the two firms. Cendana’s relationships with its portfolio funds, including Lerer Hippeau, Forerunner Ventures and Bowery Capital, are helping it take the lead on sourcing secondary deals. It then passes these opportunities to Kline Hill, which values, underwrites and negotiates the transaction price.
While Kline Hill has been investing in secondary VC since the firm’s founding in 2015, Chris Bull, a managing director at the firm, said that partnering with Cendana brings the type of information that’s extremely valuable to the investment process.
“What’s most exciting for us is we’re able to get transactions done where I think either of us individually would have had difficulty getting across the line,” Bull said.
The current plan is to invest the whole $105 million fund through the end of 2024. The two firms are giving this joint venture a try, and if it goes well, they’ll raise a successor fund next year.
The two firms are not alone in noticing a large opportunity in scooping up previously owned venture stakes. Traditional secondary investors, such as Lexington Partners and Blackstone, recently raised their largest secondary funds ever. While these vehicles target all types of private assets, investors say a portion of that capital is bound to go to venture. In addition, Industry Ventures has picked up a nearly $1.5 billion fund dedicated to secondhand VC.
But billion-dollar funds like these “typically focus on much, much larger, more multistage firms,” Kim said. Applying such big finance tactics to the seed stage is far less prevalent.
Kline Hill/Cendana is on to something. With VC-backed companies tending to stay private longer than their investors’ 10-year fund cycles, the need for liquidity will likely only continue to grow.
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