If you ask investors to name the biggest challenge facing venture capital today, you’ll probably get a nearly unanimous answer: lack of liquidity.
Despite investing in startups or venture capital funds that have risen in value due to a dearth of IPOs, those bets aren’t generating much, if any, cash for their backers. That is the disadvantage of private investment compared to the public market. Shares of private companies, such as startups, cannot be sold at will. Companies must authorize their existing investors to sell their shares to approved others, known as secondary sales.
Cash-hungry venture investors, whether venture capitalists themselves or their limited partners, are increasingly looking to sell their illiquid positions to secondary buyers.
Now, add that many early-stage startups were overvalued during the fundraising frenzy that peaked in 2021 and those stocks may now be worth less. This presents a new and unique opportunity to buy stakes in early-stage venture capital funds, as well as shares in startups, at relatively cheap prices.
Today, Cendana Capitala fund of funds that invests in dozens of early stage venture companies, and partner Kline Hill Partners, a firm focused on buying previously owned small private assets, is announcing a new fund from Kline Hill Cendana Partners of $105 million, well above the $75 million target they initially hoped to raise.
“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 CEO of Cendana Capital.
Kim felt the opportunity to increase his company’s ownership in venture funds and promising startups at a substantial discount was too good to pass up. But since investing in non-core 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 tap into this buyer’s market.
“We just passed the hat to our existing LPs in Kline Hill and Cendana,” Kim said.
Buy shares in seed funds
Michael Kim, Founder and CEO of Cendana Capital. Image credits: Michael Kim
What sets the Kline Hill/Cendana investment vehicle apart is that it purchases non-core interests in early-stage companies and individual companies from seed funds. Most of the existing supporting players are too big to take advantage of this opportunity, according to Kim.
It’s hard not to see the symbiosis between the two companies. Cendana’s relationships with funds in its portfolio, including Lerer Hippeau, Forerunner Ventures and Bowery Capital, are helping it take the lead in pursuing 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 venture capital since the company was founded in 2015, Chris Bull, the company’s CEO, said partnering with Cendana brings the type of information that is extremely valuable to the investment process.
“What’s most exciting for us is that we can make transactions that I think any of us individually would have had a hard time crossing the line.” said Bull.
The current plan is to invest the entire $105 million fund through the end of 2024. The two companies are testing this joint venture and, if it goes well, they will raise a successor fund next year.
The two companies aren’t the only ones seeing a big opportunity in picking up previously owned venture stakes. Traditional secondary investors, such as Lexington Partners and black stone, recently raised the largest secondary funding in their history. While these vehicles target all types of private assets, investors say some of that capital will almost certainly go to venture companies. Besides, Industrial business has acquired a fund of almost $1.5 billion dedicated to second-hand venture capital.
But billion-dollar funds like these “typically focus on much, much larger, more staged companies,” Kim said. The application of such important financial tactics to the initial stage is much less common.
Kline Hill/Cendana is right. Since venture capital-backed companies tend to stay private longer than their investors’ 10-year funding cycles, the need for liquidity will likely continue to grow.
