Early investors in startups are looking to exit or at least trim stakes at a time when investment inflows have dried up as the startup ecosystem endures a prolonged funding winter. Industry experts said this has led to a sharp fall in valuations of the secondary stake sale in these privately held firms.
In most cases, where there is no possibility of an immediate primary funding round, which provides a window to early backers to take some money off the table, these investors are forced to undertake secondary sales at a steep discount of 50-60%. is done. These valuations are usually benchmarked to the valuation of a company during its last primary funding round.
A secondary stake sale in startups such as Lenskart, Moglix, Postman, Chargebee, and Razorpay is being worked out, according to investment bankers, lawyers, fund managers and market intermediaries.
The most important metric the fund tracks is distributed paid-in capital (DPI) or how much capital is sent back to limited partners (LPs) each year. The ecosystem is more disciplined when it comes to this metric, which is one of the key reasons for the rise in secondary deals, said Neeraj Shrimali, managing director – digital and technology investment banking at Avendus Capital, an indigenous investment bank.
“When good companies do not have the primary capital required, deals are done keeping in mind that secondary is the only way good investors can access these companies. Secondary transactions of scale are more appreciable in slightly advanced stage companies such as growth stage, Series C+ and companies with good cash in the bank.
Most industry experts also expect more capital inflows into LPs through secondary deals in 2023 and 2024 than in the past few years.
“We are already seeing a good number of inquiries from potential vendors wanting to exit in some way. As the funding winter continues, more sellers are likely to seek secondary sale options rather than bank on the IPO or rely on a portfolio company to exit as part of a larger primary round,” Suchai Iyengar , MD and head of Capita Marketplace, a secondary platform facilitating buying and selling of private market securities. He said sellers are mostly institutions looking to offload their holdings to either partially repatriate some capital distribute to limited partners, or entirely, due to fund life considerations. The discount offered by buyers to secondary is in some cases 50% or more. This is more pronounced in companies that are not so good. Well-established business models and/or don’t have a high burn. The best companies can expect a premium, too. Based on growth and profitability metrics.”
At a deep discount of around 50%, only funds nearing maturity are likely to exit their investments, while those in the middle of their fund life are likely to hold on in the hope that sentiment will improve.
As liquidity continues to dwindle, most companies, except early stage businesses, are finding it difficult to raise fresh capital. Investors who are well capitalized and do not have an immediate need to raise fresh equity are looking for cash.
“In a lot of businesses where growth and unit economies are sustainable, it is easier to do secondary deals. In the last leg, valuation metrics have contracted,” said Mohit Agarwal, head, digital and technology, investment banking, HDFC Bank.
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