In a slow exit market, venture capital firms are turning to liquidity strategies typically used in private equity. One of these is the creation of continuation funds to extend the life of investments beyond a 10-year fund term and to provide returns to limited partners.
Crunchbase News recently spoke with Mathew Eapen, partner, and Shane Goudey, partner and chair of the venture funds practice at law firm Sidley Austin. They advise private investment funds, including venture capital and private equity, on their formation and ongoing operations.
“Private equity is very well versed in secondary transactions,” Goudey said. “The venture world is getting caught up very quickly, and continuation funds is an example of that.”
The No. 1 issue for venture fund managers in this market is liquidity pressure, he said.
“Venture funds are being raised every three to four years, if not quicker than that. And the fuel in the tank is distributions from the underlying fund managers, or some type of liquidity.”
That liquidity pressure has ratcheted up in recent years as venture firms have raised multibillion-dollar funds from endowments, pension plans, sovereign wealth funds, fund of funds and gatekeeper organizations with their own fiduciary asset management duties. In 2022, Andreessen Horowitz raised $9 billion across three funds while Lightspeed Venture Partners raised $6.7 billion across three funds. New Enterprise Associates raised $6.2 billion across two funds in 2023.
“Venture horizons are very long, and they’re getting longer by the day from a liquidity standpoint,” said Goudey.
A continuation fund allows a manager to maintain a longer relationship with portfolio companies they believe are still maturing.
Lightspeed and NEA, among others, are pursuing continuation fund strategies, according to a recent report from Axios. Insight Partners closed on continuation fund 3 in October 2024, a $1.5 billion fund led by HarbourVest Partners.
For smaller managers, these funds are not an option because they are so costly and labor-intensive. Smaller funds looking for liquidity tend to sell some of their portfolio to secondary buyers.
‘PE-ification’ of venture
“Continuation funds started out of the great financial crisis and then became larger in private equity in 2016 through 2019, and have exploded since then,” said Eapen.
“In private equity, where you own 100% of the company, and you have 10 to 15 portfolio companies in your fund, it’s a very different analysis — because the amount of time and energy and communication with LPs is a different calculus,” he said.
“Whereas for venture, when you have hundreds of portfolio companies — they shied away from it for a while, because of the complexity, because of the costs, because this is essentially viewed as what private equity does,” said Eapen.
The structure
To set up a continuation fund, a venture firm must become a registered investment adviser. A firm creates a new vehicle, rolls certain assets into it, and finds a new buyer.
Current investors in a fund can continue to hold their interest, sell it all or sell a portion. They can also choose to make a new commitment, said Eapen.
These transactions are complex, and can be structured in lots of different ways.
“The best synergies here are when the general partner, the LPs and the new buyer all agree this is what we’re looking to do, these are the commercial drivers of it. And everyone is on the same page as to how risk is allocated, how conflicts are disclosed and how costs are being split up,” he said.
Fee intensive
“It’s very fee intensive, but also time intensive,” Eapen said. Lots of service providers, from law firms to accountants, are involved. Firms have to engage with all LPs in a fund to get consent, review fund documents, work with a valuation expert, form a fund, find a buyer, negotiate an agreement and manage all the disbursements.
“It really is a very complicated M&A transaction,” he said.
Early days
“The secondary market is very robust now, but we are still in early days for penetration through lots of different investment strategy managers,” Eapen said. “And I think as the number of secondary buyer firms increases, as the adoption becomes more mainstream, the cost to entry will continue to be pushed down.”
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Illustration: Dom Guzman
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