Limited partners selling their investment stakes in venture capital funds to other LPs on the secondary market is nothing new. But traditionally these transactions happen offline through an opaque network of brokers that could charge costly fees and prove prohibitive for certain LPs to participate. Palico is looking to change that.
Paris-based Palico quietly got approval from the Financial Industry Regulatory Authority (FINRA) in July to be the first company able to facilitate end-to-end LP secondaries transactions online as an electronic trading system (ETS). This approval could have large implications on the LP-led secondaries market as LPs need sources of liquidity as companies stay private longer and small LPs get overlooked by brokers.
Palico is set up as a marketplace. LPs looking to sell either a single fund stake, or a group of stakes from different funds, upload a data room of information on what they are selling. Buyers on the platform can request access to an LP’s data room and then get in touch if they are interested.
Christopher Jeffery, a general manager at Palico, told TechCrunch that Palico started building up its marketplace over two years ago. Originally, it was a place for sellers and buyers to get connected before taking a deal offline. Palico expects to launch the capability to buy directly on the platform by the end of the summer. Jeffery said the platform offers a standard set of deal terms for each transaction, but LPs don’t have to use them.
“Buyers very easily come and see what is for sale and essentially bid on the stake, or the portfolio, and allow the seller to choose and conclude that deal,” Jeffery said. “Honestly in practice it isn’t too different to how eBay works when you transact on it.”
This news comes at a time when venture secondaries are really exploding. While a lot of the recent attention centers on direct secondaries buying an existing stake in a single company, the LP side is heating up, too, Jeffery said. LPs also need liquidity because venture capital firms, which already hold portfolio companies longer than any other asset class, hold onto companies even longer.
“There are also a lot of sellers that look at secondaries as a portfolio management tool,” Jeffery said. “A lot of institutional investors are becoming a lot more sophisticated about secondaries.”
The makeup of what LPs and GPs look like in venture has changed a lot, too. Venture capital was once a handful of firms that dominated the cottage industry backed by large institutional LPs. That’s changed. The proliferation of micro and emerging VCs over the last 10 years, and even more so over the last five, has created a very different market. Smaller funds means smaller LP stakes. While Palico can work with LPs of all sizes, it fills the biggest need for smaller LPs that are often unable to work with secondaries brokers.
“Much like in real estate, those brokers are heavily incentivized to focus on the large tickets,” Jeffery said. “That’s where [Palico] has a lot more value. We have trades starting at $1 million. One of the main things is just having a venue where you can get a cost-effective way to sell smaller stakes. If [brokers] start doing stakes that are sub $20 million or sub $10 million, they will have to increase their fees.”
While Palico is the first company to get approval to facilitate LP-led secondaries transactions online, it likely won’t be the last. But it will probably be the only for at least a while. Many secondaries-focused startups have launched in the last few years, including Caplight, Hiive and Notice, but almost all of them are focused on direct secondaries.
Jeffery said that isn’t surprising, saying that direct secondaries can be a little easier to quantify on the data side as many company valuations on the direct secondary market are tied to primary valuations from funding rounds or mutual fund marks. Pricing an LP secondary stake is a little bit more complicated.
“At the fund level, each fund might share many of the same underlying companies but they aren’t made up the same way,” Jeffery said “You aren’t able to standardize each fund as easily.”
But as more buyers enter the LP-led secondaries market, and LP liquidity issues don’t seem poised to change anytime soon, Palico is well set up to meet the LP-led secondaries market’s growing demand.
“The broader secondaires space will continue to grow, it still makes up a tiny portion of the overall AUM in private markets,” Jeffery said. “Institutional investors, they’ve only put more and more money into alternatives. Those funds will get older and you want to see what you can do with those funds. More funds will be put to play in secondaries for sure.”