Limited partners selling their investment interests in venture capital funds to other LPs in the secondary market is not new. But traditionally, these transactions have been conducted offline through opaque broker networks, charged high fees and can be difficult for some LPs to participate in. Palico is looking to change that.
Paris-based Palico quietly received authorization from the Financial Industry Regulatory Authority (FINRA) in July to become the first company able to facilitate end-to-end LP secondary trading online as an electronic trading system (ETS). This authorization could have a major impact on the LP-driven secondary market, as LPs need sources of liquidity as companies remain private for longer and smaller LPs are overlooked by brokers.
Palico is set up as a marketplace: LPs who want to sell shares of a single fund, or a group of shares of multiple funds, upload a data room with information about the product they are selling. Buyers on the platform can request access to the LP's data room and get in touch if they're interested.
Palico general manager Christopher Jeffery told TechCrunch that Palico started building its marketplace more than two years ago. Originally, the marketplace was a place for buyers and sellers to connect before transacting offline. Palico plans to launch direct buying on the platform by the end of the summer. Jeffery said the platform offers standard terms for each transaction, but LPs are not required to use them.
“Buyers can simply see what's for sale and essentially place a bid on a stock or portfolio, allowing the seller to make their selection and close the deal,” Jeffrey says, “and honestly, it's actually not that different from how it works if you were to transact on eBay.”
The news comes at a time when venture secondaries are exploding. Jeffrey said that while a lot of the attention lately has been focused on direct secondaries, which buy existing shares in single companies, the LP side is also heating up. LPs also need liquidity because venture capital firms, which already hold their portfolio companies longer than any other asset class, will hold them even longer.
“There are a lot of sellers who are looking at secondaries as a portfolio management tool,” Jeffery says. “A lot of institutional investors are starting to take a pretty sophisticated view of secondaries.”
The composition of LPs and GPs in venture has also changed significantly. Venture capital used to be a small industry dominated by a few firms backed by large institutional LPs. But things have changed. Over the last decade, and even over the last five, the market has changed dramatically with the proliferation of micro and startup VCs. Smaller funds mean smaller LP stakes. Palico can work with LPs of all sizes, but it meets the greatest needs of smaller LPs who often can't work with secondary brokers.
“Just like in real estate, these brokers are highly incentivized to focus on big deals,” Jeffrey said. [Palico] It's much more valuable. You can trade from $1 million. One of the key things is to have a place where you can sell small amounts of stock in a cost-effective way. [brokers] “If you start betting less than $20 million, or even less than $10 million, you're going to have to raise your fees.”
Palico is the first company licensed to facilitate LP-led secondaries online, and likely won't be the last, but it will likely be the only one, at least for a while. A number of secondary-focused startups have launched in the last few years, including Caplight, Hiive, and Notice, but most are focused on direct secondaries.
That's not surprising, Jeffrey said, noting that it's a little easier to quantify direct secondaries data-wise because a lot of company valuations in the direct secondary market are tied to primary valuations from fundraising rounds or mutual fund marks. Pricing LP secondary shares is a little more complicated.
“At the fund level, while the funds may share many of the same underlying companies, they're not structured in the same way,” Jeffery said. “You can't really standardize each fund that easily.”
However, with more buyers entering the LP-led secondary market and LP liquidity issues not expected to change anytime soon, Palico is well positioned to meet the growing demand in the LP-led secondary market.
“The secondaries market will continue to grow, but it's still a very small portion of the private market's assets under management,” Jeffery said. “Institutional investors are putting more and more money into alternative investments. That money is going to age and they want to see what they can do with it. We're definitely going to see more money going into secondaries.”