In this episode of the EUVC podcast, Andreas talks with Alberto Chalon, founding GP of Giano Capital and an expert with a decade of experience in venture secondaries.
Andreas and Alberto dive deep into the sell-side of venture secondaries, exploring the fundamentals that drive the market, the motivations of key players, and the nuances of preparing for a sale. Alberto shares his sophisticated approach to buyer processes, using a quantitative scorecard, and provides a practical guide for sellers navigating valuation, pricing, and legal challenges. Their conversation also addresses the current dynamics and trends shaping the secondaries market, offering a comprehensive look at what it takes to succeed.
At Giano Capital, Alberto specializes in secondaries, drawing on his extensive experience to drive value for both buyers and sellers. This episode is packed with real-world insights and practical examples, making it an essential listen for anyone looking to understand or engage in the world of venture secondaries.
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✍️ Show notes
Understanding the Secondaries Market
Background on what leads to a Secondaries market – why people may want to sell
Background on the Secondaries Market:
Over the last 20 years, exit timelines have extended significantly.
In the early 2000s, companies could go public quickly with little revenue, often leading to premature exits.
Today, the average exit for a company is 12-16 years, often waiting to reach $100 million+ in revenue.
The IPO market has slowed down, making secondaries more important for liquidity.
Even when IPOs are possible, companies prefer to exit later as “bigger is better” in terms of valuations.
Opportunity in Europe vs. U.S.:
U.S. investors are more aggressive, leading to an earlier boom in the secondaries market.
Europe, as usual, lags behind the U.S. by 5-7 years in secondaries activity.
In Europe, there is a growing need for secondaries as companies take longer to exit, and liquidity is required.
Types of Sellers in the Secondaries Market:
Founders and Employees:
These sellers may have been with the company for 7-10+ years and have significant paper wealth.
They seek to monetize up to 20% of their holdings for personal reasons like buying property or funding their children's education.
Selling a portion of their stake keeps them motivated while providing some financial security.
Early-Stage Investors (Business Angels, Seed Investors, VCs):
These investors are looking to generate liquidity after holding their stakes for several years.
VCs, in particular, are under pressure to show DPI (Distributions to Paid-In Capital) to raise new funds.
Business angels want to cash out their investments to fund new ventures, which aligns with their role as early-stage supporters.
The Role of Intermediaries:
In the U.S., intermediaries (like brokers) often handle deals, though they might not provide full support.
In Europe, large banks (Goldman Sachs, Morgan Stanley) or M&A boutiques sometimes manage secondaries, especially in deals over $30-$50 million.
For smaller deals, direct interaction between the buyer and the seller, like Giano Capital’s approach, is more common.
US vs Europe - what to keep in mind
Mindset is very different, most US investors are more risk takers
Mindset Differences:
US Investors: Generally more willing to take risks, which drives more aggressive investment strategies and early adoption of secondary transactions.
European Investors: Tend to be more conservative and risk-averse, with slower adoption of secondary markets, trailing the US by about 5-7 years.
Regulatory and Market Structure:
US Market: The ecosystem in the US allows for more fluid transactions due to transparency and access to information.
Public filings and accessible data on private companies allow investors to make informed decisions more easily.
European Market: Private companies maintain more confidentiality.
Investors need to work harder to get access to founders, management teams, and financial data, requiring a more relationship-driven approach.
This limitation slows down secondaries and makes the process more complex compared to the US market.
Access to Information:
In the US, investors can often rely on public data and readily available information on private companies to make decisions.
In Europe, due diligence relies heavily on personal access to management, cap tables, and private company information, often requiring direct conversations and strong networks to get the necessary data.
Cultural Approach to Growth and Exits:
US: Investors focus more on rapid growth and taking companies public earlier in their lifecycle, even before reaching high revenue milestones.
Europe: Companies tend to stay private longer, often waiting until they reach $100 million+ in revenue before considering an exit. This extended timeline provides more opportunities for secondary transactions in later stages.
Key Players and Stakeholders
Types of Sellers: Categories and Motivations
Employees & Founders:
Motivation: Over time, these stakeholders accumulate value in their equity but often need liquidity for personal reasons.
Impact: Selling part of their equity allows founders to stay committed to the business, while managing personal financial risk. This enables them to support their family or buy property, keeping them motivated for the long run.
Early Stage Investors:
Business Angels (BAs):
Motivation: BAs have typically already seen large returns on their investment. They are often eager to exit after having added all the value they can.
Impact: Happy to clear their position, take the rewards, and move on to the next project.
Seed and Round A Investors:
Motivation: These investors usually need to secure liquidity well before the final exit to maintain credibility.
Impact: To successfully raise a follow-up fund, they need to show a healthy DPI (Distributions to Paid-In Capital), requiring partial liquidity events.
Role of Intermediaries for Sellers:
Types of Intermediaries:
US Market: Filled with brokers who facilitate both supply and demand in secondary transactions.
Europe: Fewer intermediaries; here, banks and M&A boutiques (like Goldman Sachs or Deutsche Bank) handle secondary deals in a manner similar to primary transactions, but only when there’s a formal process in place.
Impact of Intermediaries:
For smaller, off-market secondaries, it’s more common for the deal to happen without an intermediary’s help. The process is more relationship-driven, and sellers often need to be prepared to manage the sale directly.
Buyer Process:
Approach of a Sophisticated Buyer:
Treating Secondaries Like Primaries: A serious buyer treats a secondary transaction with the same level of due diligence as a primary investment. Sellers should expect to share just as much information.
Key Information: Buyers will request detailed financials like the P&L, budgets, and 3-year plans, which will be fed into their decision-making scorecard.
Alberto’s Process:
Quantitative (Scorecard):
Giano Capital uses a 14-step scorecard focused on essential KPIs: CAC, profit margins, revenue growth, etc.
Screening: In the past year, they screened 100 companies and invested in only 3, while keeping others for potential future deals.
More Quantitative Detail:
Giano Capital engages with the most strategic managers (CFO, CMO, and CEO) to deeply understand the company’s numbers and future trajectory.
Forecast Reliability: A major focus is on testing how reliable the company’s forecasts have been historically to judge the quality of the data.
Qualitative Analysis:
In this step, the team dives into external references to validate the company’s strengths and weaknesses through third-party insights.
Valuation and Agreement on Price:
Public Comparables:
Focus: The multiples of public competitors are used as the baseline. Depending on the company’s specifics, they apply premiums or discounts based on growth rates, profitability, and risks.
Avoiding “Discounts”: Giano avoids framing the conversation around discounts, focusing instead on the reality of the company’s current market value. Whether it ends up being a discount or premium depends on the fundamentals.
Legals & Financial DD with Externals:
Finalizing the Deal:
Once the quantitative and qualitative assessments align, Giano proceeds to sign an LOI, which outlines the price, number of shares, and committed capital.
The legal and financial due diligence process begins, ensuring everything in the deal is aligned, from shareholder agreements to financial audits.
Other Considerations:
Deal Structures:
Liquidation preferences and other aspects of the preference stack must be carefully reviewed to determine how much protection a buyer has in case of an exit.
SPVs:
Giano generally avoids buying through SPVs unless there’s a good reason and full alignment with the company, as it limits their ability to access critical data and build relationships with management.
Closing:
Timing:
Depending on the complexity, closing a deal can take between 20-40 days, considering shareholder rights like preemption.
Preparing for a Sale from a Fund
Portfolio Assessment:
Evaluating Which Assets to Sell:
A GP must first evaluate how much DPI they need to create at a given time, then assess which assets in the portfolio are best positioned for liquidity.
Important Factors: The company should have at least $50M in revenue, 30% growth, be fully funded or profitable, and be on a clear path to an exit within the next 3 years. Market leadership is a strong positive signal.
Fire Sales:
Fire sales are typically not viable for VCs unless it involves restructuring and potential recovery of value in distressed assets.
Valuation Preparation:
Preparing Assets for Valuation:
A selling GP needs to do the same rigorous valuation work that a buyer would—assessing public comparables, applying realistic multiples, and being honest about the company’s current position.
Valuation Scorecard: Share this information in the form of a detailed, quantitative scorecard with the buyer (Alberto’s model includes 14 key elements).
Documentation & Reporting:
Ensure all necessary documentation is ready and accurate before engaging buyers, from financial reports to detailed business plans.
Valuation and Pricing:
Valuation Techniques for Sellers:
Use public comparables to set realistic valuations.
Bull Case: Management’s optimistic projections.
Base Case: A more conservative approach, with a 20-30% discount from the bull case.
Bear Case: Apply a 50% discount to key financial metrics and compare public market multiples to estimate the downside.
Factors Influencing Pricing for Sellers:
Asset Quality: Buyers will focus on what shares are being sold, associated rights, and the market demand for those assets.
Market Conditions: General public market multiples will affect pricing, but specific company performance relative to the market can push for a premium.
Seller’s Needs: These don’t influence the buyer’s valuation—buyers are more concerned with the company’s situation, not the seller’s desires. Giano’s long-term strategy is to avoid being perceived as opportunistic, focusing instead on sustainable, well-priced deals.
Legal and Regulatory Considerations for Sellers in the Secondaries Market
Regulatory Landscape:
The regulatory landscape around secondary transactions varies significantly between regions, with the U.S. often having more established frameworks due to the volume of transactions. In Europe, secondary transactions are becoming more prevalent, but the market is still evolving and tends to lag behind the U.S. by a few years.
US vs. Europe: One of the key distinctions between the U.S. and European markets is the level of transparency. In the U.S., there’s more access to public filings and information, which makes it easier for investors to conduct due diligence. In contrast, European private companies are more secretive, and investors must rely on direct relationships with founders and managers to access critical information.
Impact on Sellers: In Europe, sellers must be prepared for stricter privacy regulations and more complex access requirements. They will likely need to facilitate introductions between potential buyers and company management to ensure all necessary details are disclosed.
Compliance Requirements:
Ensuring Legal Adherence: Sellers must ensure that they comply with all local laws and regulations, especially around shareholder rights. For instance, many shareholder agreements in Europe include preemption rights, where existing shareholders must be given the first right of refusal on any sale. This can extend the timeline for closing a deal, as it typically takes between 20-40 days to complete the preemption process.
Communication with Founders and Management: It is essential to align any sale of secondary shares with the founders and management team, as their consent is often needed to avoid conflicts or breaches of shareholder agreements. Transparency about the motivation behind selling—whether for liquidity or other reasons—helps ensure smooth communication and avoids misunderstandings about the seller’s belief in the company.
Transaction Documentation:
Key Legal Documents:
Shareholder Agreement: This governs the rights of shareholders and will often include clauses around preemption, tag-along, or drag-along rights that can affect the sale of shares. Sellers need to ensure that any transaction adheres to these provisions.
Term Sheet: Once the buyer and seller agree on price and terms, a binding or non-binding term sheet is signed. This document outlines the number of shares, price, and key conditions.
Legal Due Diligence: Buyers typically conduct a thorough legal due diligence process, reviewing the company's financial statements, checking compliance with regulations, and ensuring that the company’s shareholder agreements and other legal frameworks are in place.
Financial Due Diligence: Sellers must also provide audited financial statements or other official accounts to ensure the buyer has full visibility into the company’s financial health. Additionally, buyers may engage third-party auditors to verify financial data provided by the company.
Timing and Process: After legal and financial due diligence, closing the deal can take between 20-40 days, depending on the specifics of the shareholder agreement and any legal requirements for the sale.
By understanding the regulatory environment, complying with legal standards, and ensuring all transaction documentation is in order, sellers in the secondaries market can navigate these processes efficiently, reducing the risk of legal complications and delays.
Key Hurdles That Can Impact Secondaries
Alignment of Interests:
One of the major challenges in secondary transactions is ensuring that the interests of all parties—founders, investors, and employees—are aligned. For example, early-stage investors might need liquidity, but founders may prefer to retain control or avoid signaling a lack of confidence in the company. Ensuring alignment, especially when seeking partial exits, can make or break a deal.
Solution: Clear and transparent communication about the need for liquidity, coupled with presenting it as part of a broader strategy (e.g., increasing DPI for venture funds), can help smooth over potential conflicts.
Governance Restrictions:
Shareholder Agreements: Many shareholder agreements include governance restrictions such as preemption rights, tag-along rights, or drag-along rights. These provisions can slow down a secondary sale, as the seller must first offer shares to existing shareholders or comply with other governance requirements.
Impact: These governance hurdles can add weeks or even months to a transaction, depending on how the rights are structured and whether existing shareholders are interested in exercising their options.
Complexity and Timing:
Complexity: Secondary deals can be more complex than primary investments, particularly when it comes to accessing information. Unlike primary transactions, where companies are eager to share data, secondary buyers may face reluctance from founders or other investors, particularly if they feel the transaction could negatively impact company valuation or control.
Timing: The timing of secondary sales is critical, and transactions can be delayed due to market conditions, company performance, or governance-related roadblocks. It's important to start the process early and prepare all necessary documents and permissions.
Market Dynamics and Trends:
Current Trends Impacting Sellers: The secondary market has grown rapidly in recent years due to longer exit timelines (12-16 years for most companies), delayed IPOs, and the growing preference for companies to stay private longer. Sellers need to navigate a more cautious market, with buyers becoming selective about growth, profitability, and future exit potential.
Solution: Understanding market trends and how they affect valuations is critical. For instance, in down markets, sellers might face more scrutiny from buyers, but in times of heightened M&A activity, liquidity events could become more accessible.
Market Drivers:
Growth Drivers: The increasing need for liquidity, particularly among early-stage investors and employees, is a key driver of the secondaries market. As companies stay private longer and the IPO window shrinks, secondaries provide an important outlet for early investors to realize returns.
Strategic Buyers: In recent years, private equity firms and later-stage investors have become more active in the secondaries market, looking for growth-stage companies with substantial revenue and profitability.
Future Outlook for Sellers:
Predictions: As companies continue to stay private longer and public markets remain volatile, the secondaries market is expected to keep growing. More structured, formal processes for secondary sales could emerge, particularly in Europe where the market is less mature.
Potential Developments: Emerging online platforms and technology-driven solutions are likely to make it easier for sellers to find buyers and streamline transactions. Additionally, as more funds look to improve their DPI, secondary transactions will become more common as a strategic tool for venture capital firms.
Selling Strategies
Timing the Sale:
Optimal Timing: The best time to sell is often when a company has shown sustained growth, ideally reaching $50M+ in revenue with clear paths to profitability or exit within 3-5 years.
Market Timing Considerations: Sellers must also keep an eye on market conditions. In down markets, buyers may expect larger discounts, but in buoyant times, sellers can command a premium.
Marketing Your Assets:
Effective Strategies: To market your secondary shares effectively, it’s important to position them as part of a broader liquidity event that benefits the company, rather than as an exit driven by lack of confidence. Engaging directly with potential buyers and leveraging intermediaries can also enhance the visibility of the opportunity.
Negotiation Tactics for Sellers:
Negotiating Terms and Pricing: Successful negotiation requires focusing on market comparables and clear growth trajectories. Sellers should avoid framing deals around discounts and instead emphasize market realities—whether there’s a premium or discount will depend on the company's specifics.
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