Venture capital firms are increasingly using continuation funds as a strategic response to a challenging market characterized by a lack of exits over the past two years. This trend is not limited to established U.S. firms grappling with deeply discounted assets; it is also gaining traction in emerging markets.
London-based Nodem Capital, founded by Alex Branton, is pioneering the continuation fund model in what he terms “next wave” markets, including Emerging Europe, Turkey, Latin America, Southeast Asia, and India. By offering secondary liquidity to holders of VC-backed assets, Nodem aims to address the growing demand for liquidity solutions in these regions.
The growth of next wave markets peaked in 2021, with VC funds raising approximately $57 billion, driven by successes in Chinese and mobile internet sectors. As many of these funds approach their 10-year mark, they are faced with the challenge of managing residual assets that have yet to find an exit. Branton notes that the current landscape shows a significant overhang, with 20 times more companies financed by VCs than those that have successfully exited. This situation has led to a reluctance among limited partners (LPs) to commit to new funds until value is unlocked from earlier vintages.
Nodem Capital is positioning itself as a vital player in this evolving landscape, anticipating a substantial increase in the investable universe of assets held in VC funds older than 10 years, projected to rise from $15 billion to around $130 billion. The firm plans to focus on sectors like FinTech, which has historically provided profitable exits in next wave markets, generating $133 billion since 2018. Branton emphasizes the vast opportunity available, stating that many VC funds currently have “nowhere to turn” for liquidity.
The firm’s strategy involves offering partial liquidity through preferred equity investments, catering to “non-sellers” who wish to maintain exposure and control over their tech assets while still accessing liquidity for distributions. Nodem is set to begin investing in the first quarter of 2025, pending regulatory approvals. Its initial investors include individuals from leading investment firms and some large U.S. endowments participating in a co-investment program. The fund will operate under a 2 and 20 fee structure and will have a five-year lifespan, with an option to extend for an additional two years.
The concept of continuation funds has gained significant traction in the broader private equity sector in recent years, although investor enthusiasm has waned recently due to concerns over conflicts of interest and high fees. Venture capital firms, facing an even more challenging environment than their private equity counterparts, have been slower to adopt this trend. The plummeting valuations post-2022 have prompted some notable VCs to explore continuation funds as a viable option.
Prominent firms such as Lightspeed Venture Partners are in the process of raising substantial continuation funds, with Lightspeed targeting $1 billion. Other major players, including General Catalyst, New Enterprise Associates, RockPort Capital, Insight Partners, and Trinity Ventures, are also reportedly forming continuation funds. However, not all attempts have been successful; for instance, Shasta Ventures faced rejection from limited partners when it sought to transfer nearly all its holdings into a continuation fund, which was priced at 65 percent of its value in the third quarter of 2023.
The venture capital landscape is undergoing a significant transformation as firms navigate the complexities of continuation funds. While the potential for liquidity solutions is evident, the challenges associated with investor confidence and the management of existing assets remain critical hurdles. The reluctance of LPs to commit to new funds until earlier investments yield returns underscores the need for innovative strategies that can unlock value in a stagnant market.
As firms like Nodem Capital step into the fray, the focus on next wave markets presents a unique opportunity for growth and investment. The emphasis on sectors such as FinTech, which have demonstrated resilience and profitability, could pave the way for a new era of venture capital investment. The ability to provide liquidity while maintaining asset control may attract a new class of investors eager to capitalize on the potential of these emerging markets.
In summary, the evolution of continuation funds within the venture capital space reflects a broader trend of adaptation and innovation in response to market challenges. As firms explore new avenues for liquidity and investment, the landscape is poised for significant changes that could redefine the future of venture capital.