If you ask investors to name the biggest challenge facing venture capital today, you’ll likely get a near-unanimous answer: lack of liquidity.
Despite investments in startups or VC funds that have increased in value due to the lack of IPOs, these bets don’t make their backers much money, if any. This is the disadvantage of private investment compared to the public market. Shares in private companies such as startups cannot be sold at will. Companies must allow their existing investors to sell their shares to approved third parties, known as secondary sales.
Cash-hungry venture capital investors, whether VCs themselves or their limited partners, are increasingly looking to sell their illiquid positions to secondary buyers.
Add to that the fact that many young startups were overvalued during the fundraising frenzy that peaked in 2021, and those stocks may be worth less now. This represents a new and unique opportunity to acquire shares in seed-stage VC funds as well as shares in startups on relatively favorable terms.
Today, Cendana Capital is a fund of funds that invests in dozens of Seed-stage venture firms and partners Kline Hill Partners, a firm focused on purchasing small, privately held assets, announced a new $105 million Kline Hill Cendana Partners fund, well above its original target of $75 million.
“Over the last two years, we’ve heard from our portfolio funds: ‘We have a family office that wants to sell its $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 company’s exposure to venture funds and promising startups at a significant discount was too good to pass up. However, because investing in secondary assets requires expertise that none of the Cendana investors had, he decided to work with Kline Hill.
Raising money for this fund was easy, Kim said. Cendana’s limited partners asked Kim to take advantage of this buyer’s market.
“We just passed the hat on to our existing LPS in Kline Hill and Cendana,” Kim said.
Purchase of stakes in seed capital funds
What sets Kine Hill Cendana’s investment vehicle apart is that it buys secondary stakes in seed companies and individual companies from seed funds. According to Kim, most existing secondary players are too large to take advantage of this opportunity.
Michael Kim, founder and managing director of Cendana Capital
It’s hard not to see the symbiosis between the two companies. Cendana’s relationships with its portfolio funds, including Lerer Hippeau, Forerunner Ventures and Bowery Capital Kline, help the firm take the lead in sourcing secondaries. These opportunities are then passed on to Kline Hill, which evaluates, underwrites and negotiates the transaction price.
While Kline Hill has been investing in secondary VC since the company’s founding in 2015, Chris Bull, the company’s managing director, said the partnership with Cendana brings information that is extremely valuable to the investment process.
“The most exciting thing for us is that we are able to do transactions that I think any of us individually would have had difficulty getting across the border.” Bull said.
The current plan is to invest the entire $105 million fund by the end of 2024. The two firms are trying out this joint venture, and if it goes well, they will launch a follow-on fund next year.
The two companies are not the only ones who recognize a great opportunity if they first acquire their own venture shares. Traditional secondary investors, such as Lexington Partners And Black stone, recently launched their largest secondary funds ever. While these vehicles target all types of private wealth, investors say some of that capital will inevitably flow into venture capital firms. Additionally, Industry companies has launched a nearly $1.5 billion second-hand VC fund.
But multi-billion dollar funds like this “typically focus on much, much larger, multi-stage companies,” Kim said. Applying such big financial tactics to the seed stage is far less common.
Kine Hill Cendana is up to something. Since venture capital-backed companies tend to stay private longer than their investors’ 10-year fund cycles, liquidity needs are likely to continue to increase.