Investments in the venture capital secondary market can basically be divided into two main categories: fund-related transactions (“fund interest investments”) and direct transactions (“direct secondary investments”).
Fund Interest Investments
These transactions, which are primarily known from the private equity segment, relate to the purchase and sale of investments in venture capital or private equity funds. In so-called LP-led transactions, the sale is initiated by one or more limited partners (LPs). GP-led transactions, on the other hand, are initiated by the fund management (general partners, GPs) – often in the context of restructuring or so-called continuation funds.
Direct Secondary Investments
Direct secondary investments differ from fund interest investments in that they involve the direct acquisition of company shares in venture capital-financed portfolio companies – for example from early investors, business angels, existing shareholders or former employees. This gives investors direct access to individual companies without having to rely on the performance of a fund or a traditional exit. According to estimates from 2021, direct secondary investments account for around 85% to 90% of the total transaction volume in the venture capital secondary market. Even if these figures should be treated with caution given the inherent lack of transparency in the market, they nevertheless illustrate the increasing relevance of this segment.
Legal and practical challenges
Direct secondary investments are associated with a number of legal and practical challenges – primarily due to the often-complex capital structure of venture capital-financed companies that has grown over several financing rounds. The so-called cap tables usually contain a large number of different forms of participation such as ordinary shares, convertible preference shares, convertible loans, subscription rights or options. These differ not only in terms of economic rights, but also in terms of liquidation preferences and exit proceeds distribution preferences. Careful and in-depth legal due diligence is therefore essential. Buyers must fully understand the capital structure, contractual agreements and tax and corporate law implications – misjudgments can have serious financial consequences.
Special legal factors
In addition to the complexity of the capital structure, there are a number of other legal pitfalls: contractual structure and approval requirements: In Germany, transfers of shares in GmbHs require notarization in accordance with Section 15 (3) GmbHG. In many cases, the consent of the co-shareholders or the company itself is also required, whether through the articles of association, shareholders’ agreements or side letters.
Rights of first refusal (ROFR)
These rights, which are often regulated in shareholder agreements, oblige sellers to first offer shares to other shareholders with priority. Their exercise can hinder or delay the transaction or exclude the original buyer.
Tag-along/co-sale rights
Co-sale obligations can legally complicate direct secondary transactions. Minority shareholders must be involved in the sale by the seller at least pro rata, depending on the contractual structure.
Information rights and disclosures
Buyers often do not have access to internal company data. The seller’s disclosure obligations and any contractual information rights, therefore, decisively determine the scope of the due diligence. It is important to involve the company in the process at an early stage in order to facilitate due diligence for potential buyers.
Liability and guarantees
Sellers regularly try to limit their liability. For the buyer, guarantees on ownership (title), encumbrances and the legal status of the shares are crucial in order to hedge risks. However, business warranties are often not part of transactions, usually because the seller is not operationally involved in the company’s business.
Special aspects under company law
Shareholding classes with different rights (e.g. liquidation and exit proceeds distribution preferences) as well as convertible loans and ESOPs can have an influence on the valuation of the shares available for sale. It is important that the corresponding special rights are directly linked to the shares and have not been granted individually to the seller and are therefore transferable.
Market performance in turbulent times
Despite these challenges, the market for direct secondary investments has seen steady growth in recent years. The tech boom of 2021, boosted by the pandemic, was followed by a phase of market correction in 2022. The valuations of listed technology companies fell significantly – with a noticeable impact on the venture capital secondary market. The growing bid-ask spread between seller expectations (highest valuations of 2021) and buyer offers (adjusted to lower multiples) led to a noticeable decline in transaction volumes. At the same time, the turnaround in interest rates led to rising financing costs and increased risk sensitivity. Only in the second half of the year 2023 did the market stabilize. Valuations reached a low point and market participants adapted to the new reality. The bid-ask spread narrowed, which led to a noticeable upturn in the market. In 2024, the venture capital secondary market therefore experienced a significant revival – fueled by the enormous investor interest in generative AI and so-called AI native companies. Another factor was the ongoing IPO slump in Europe and North America. In the absence of traditional exit options, investors are increasingly using direct secondary markets as a liquidity valve, as holding periods are extended and companies remain private for longer.
Current market development and outlook
A clear sign of the renaissance of the direct secondary market is the increase in large-volume, company-initiated takeover bids in the Anglo-American and European regions (e.g. Canva, Stripe, Databricks). There are also relevant transactions in Europe, such as the transaction of Vinted, an online marketplace for second-hand fashion. Under the leadership of TPG, a substantial amount of shares changed hands – a significant milestone for the European direct secondary market.
Direct secondary investments are playing an increasingly important role in a market environment in which traditional exits via IPOs or trade sales are only possible to a limited extent. Companies use this structure specifically to provide investors with liquidity without having to completely restructure their capital structure. At the same time, this opens up targeted entry opportunities for strategic buyers in companies with high growth potential.
In conclusion
The dynamics of the venture capital secondary market – particularly in the area of direct secondary investments – are likely to intensify further. In an environment that demands flexibility, liquidity and structural innovation, direct secondary investments offer a promising alternative to traditional exit strategies.
This article was first published in: VC-Magazin 02/2025, pp. 34/35