Earlier this year, Manan Mehta of Unshackled VC received a call from Gratitude Railroad, the asset manager and impact network. Did the venture firm have any limited partners that were itching to sell their positions?
As it turns out, like many emerging managers, Unshackled did have a few LPs interested in selling stakes in an earlier fund. Within months, Gratitude Railroad had analyzed Unshackled’s portfolio and purchased two stakes, one from a high net worth LP and the other from a venture capital firm.
“My job, as a steward of LP capital, is to constantly give my LPs the option to rebalance and realign,” says Mehta, cofounder of Unshackled, which backs early-stage impact-focused startups with immigrant founders.
Call it secondaries, impact-style.
Secondaries – the buying and selling of stakes in private funds and companies – has surged amid a prolonged exit drought that has some limited partners antsy to recoup some capital to redeploy.
The secondaries surge stands to increase liquidity throughout the impact investing ecosystem, as selling LPs are able to recycle their capital to new fund managers, who in turn are able to back new ventures. It also gives buyers a chance to get into more seasoned funds with known portfolios that they can readily assess for both returns-potential and impact.
Unshackled “is a good fit for our Inclusive Capital strategy,” Rebekah Saul Butler of Gratitude Railroad tells ImpactAlpha. “It’s a fund we are excited about bringing into our portfolio and community.”
The stake in Unshackled’s 2017-era first fund, she says, boosts Gratitude’s vintage diversity, offering a shorter time to exit. And the 10% to 30% discount to the portfolio’s net asset value, as is standard in secondary sales, provides attractive economics. The deal also gives Unshackled a liquidity solution and brings in a deeply aligned partner.
Unshackled was one of 40 or so VCs tracked by Gratitude Railroad that it reached out to. The asset manager is likely to purchase at least two more LP stakes from promising emerging managers.
“We wanted to talk to GPs we know and to work with them to ensure our efforts are aligned with their goals,” Saul Butler says. “As mission-focused investors, we aspire to work in a relational and supportive way with emerging managers, and our secondary approach needs to align with this aspiration.”
Market maturity
Private equity secondary funds raised nearly $30 billion globally in the first quarter, and assets under management for such funds could reach $1.3 trillion by 2030, according to Preqin. Investment bank William Blair projects PE and VC secondary deal value could hit $250 billion this year.
Beyond the immediate liquidity for sellers, secondary strategies offer a way for LPs to optimize and rebalance portfolios and flatten J curves (the dip fund valuations take in the early years before trending up over time) by buying into later-stage or private credit funds.
Yet the secondaries action has only recently reached the impact community. A lack of knowledge, misperceptions about pricing, and the extra considerations that impact investors bring to the table have slowed adoption.
That is shifting as more impact LPs and GPs embrace secondaries as both buyers and sellers. And they are often carving their own path, seeking additionality in what has conventionally been a purely transactional strategy.
“We’re seeing an increased interest in secondaries as an investment option for those that are investing within the impact ecosystem,” Tom Jorgensen of North Sky Capital, one of the few impact fund managers focused on secondaries, tells ImpactAlpha.
“I think that’s a natural evolution and shows the continuing maturity of this market.”
North Sky has raised an initial $235 million for its fifth secondary fund, according to an SEC filing. The firm is targeting $250 million for the fund, which pools capital to purchase stakes in impact funds and companies on the secondary market.
Jorgenson says about 5% of capital raised for non-impact funds has gone towards secondary strategies; for the impact market, it’s about 0.1%.
Recycling capital
Private market managers were expecting the exit floodgates to open this year, providing the liquidity that LPs have been waiting for. But new shocks and uncertainties have muted activity for all but the biggest and glitziest deals. Artificial intelligence has undercut the value of once-coveted software companies. The ongoing war with Iran and the shutdown of the Strait of Hormuz has stoked inflation fears.
The SpaceX IPO earlier this year raised $75 billion at a $1 trillion valuation for the rocket and AI company. Dozens of foundations invested in early impact funds managed by DBL Partners and Capricorn Investment Group may see a big windfall from that IPO, after lockup periods expire. A few others are awaiting the expected trillion-plus dollar Anthropic listing, as ImpactAlpha has reported. And the successful public debut of geothermal power producer Fervo, backed by funders including Capricorn, Elemental Impact, Galvanize and Breakthrough Energy Ventures, has laid a foundation for other promising, late-stage climate tech hopefuls.
But for most LPs, liquidity is still a challenge. Many funds, especially those started in 2000-2001 when near-zero interest rates helped inflate valuations, have struggled to return capital. The slowdown in distributions means there is less capital available to redeploy. Often, it is the non-impact portfolios that are constraining liquidity at LPs that carve out just a portion of their holdings for impact.
California Wellness, a private foundation, says it is underweighted in private markets and not facing liquidity constraints. It also has a small stake in SpaceX via a fund investment that it expects to eventually pay off. In the meantime, the foundation is looking into an impact-focused secondaries fund.
“The current environment has created attractive opportunities to acquire seasoned impact assets at compelling valuations,” Cal Wellness’ Javier Hernandez tells ImpactAlpha.
“The key question for us is impact additionality.”
Unlike primary investments, secondary transactions do not directly provide growth capital to companies — akin to trading in publicly listed companies. As a result, says Hernandez, “the impact thesis rests less on financing new outcomes and more on strengthening the impact investing ecosystem by providing liquidity, helping investors recycle capital into new opportunities, and supporting the maturation of the impact market.”
He adds that the foundation is evaluating whether the secondary fund’s approach adequately addresses this challenge, while also delivering attractive risk-adjusted returns.
Everyone is feeling the liquidity strains, says Saul Butler. “Liquidity is important for so many reasons, including to recycle capital and grow emerging efforts into larger, sustainable firms,” she says.
Gratitude Railroad says that its approach of working in a more relational way with managers, rather than through brokers or other LPs, smoothed what is often an opaque process. “We found that it was beneficial to have a trusting relationship with the fund manager, so we could have a relatively open conversation about the underlying assets and what that looks like,” says Saul Butler.
The frothy markets of five or six years ago continue to drag on liquidity and valuations from that period, she says. “But for newer funds and opportunities, the market has reset and is quite exciting and, outside of the AI bubble, fundamentals have been restored.”
The asset manager’s proactive approach provides a counter-narrative to the misperception that secondary markets suggest adverse selection, in which LPs unload only their underperformers.
“We’re saying, ‘Hey, we’re on the market for secondaries. We know you, we like your thesis,’” Saul Butler says. “We’re going outbound to folks that we know might be interested in having that conversation.”
Discounts and premiums
Of course, some investors do want to get out of funds that have not met their expectations, in order to make new investments that might. One mission-aligned nonprofit investor told ImpactAlpha it is in the market looking to sell three edtech funds that have underperformed.
“We’re looking for market rate returns and impactful outcomes. If you can get impactful outcomes, great, but market rate returns have to be there as well,” said the investor, who declined to be named.
The nonprofit investor initially committed a total of $20 million to the three funds. The managers drew down $10 million. It is now negotiating with potential buyers and expecting to take a 20% to 30% discount.
“I sell my stake for $7 million, I lose $3 million, but it releases the other $10 million that should have contributed so that I can invest in other things,” the investor said. “It’s a quick liquidity of $17 million, where I’d be otherwise I’d be locked up for 10 years.”
That kind of math is still lost on many impact LPs.
“There can be a gap in understanding in how secondary markets and pricing work,” says Gratitude Railroad’s Saul Butler, who points to the need for more education.
Even among quality portfolios in venture, a 10% – 30% discount to net asset value, or NAV, is considered market-rate, “because even under ideal scenarios, the buyer is taking on portfolio and liquidity risk,” she explains. “Many LPs are surprised by this and have challenging expectations around pricing.”
LP secondaries may be unfamiliar to emerging fund managers as well, who may be concerned about the optics of an LP selling a stake.
Unshackled’s Mehta sees the value, especially as the venture industry bifurcates into risky early stage investment and later stage growth capital.
“You’re either early like us with discovery capital, or you’re late on the other end with validation power,” he says. Buying into a portfolio that is several years old gives investors the chance to “effectively buy into the validation phase with the shorter time horizon. And you pay a market premium for it.”