Hunter Somerville on Venture Secondaries, Liquidity and LP Decisions

Hunter Somerville, a partner at StepStone, discusses venture secondaries and limited-partner liquidity with Harry Stebbings in March 2023. StepStone invests in funds, companies and secondaries, so its role as a potential buyer is relevant to his views on pricing and liquidity.

Somerville divides the market into company secondaries, sales of fund interests, and GP-led transactions such as strip sales, tenders and restructurings. He notes that others may categorize them differently. GP-led transactions can address multiple limited partners at once rather than a single bilateral sale.

Company sellers may include early friends and family, angels, seed funds and employees who have held equity for years. Some former employees may want liquidity but lack ongoing information rights. When IPOs and acquisitions slow, these holders may seek a private sale instead.

The denominator effect occurs when public holdings fall faster than private valuations, making private assets a larger share of an investor’s total portfolio. An LP seeking to rebalance may sell fund interests if valuation changes alone do not restore its target allocation.

Somerville says the venture funds he observed had marked down around 15% to 20% on average, with roughly 19% as one figure. He thinks further markdowns may be warranted but was surprised that managers had taken discretionary reductions more proactively. These are his 2023 observations, not a comprehensive market valuation.

Asked how to accommodate LPs with different preferences for marks, he recommends an independent fair-value assessment. He would examine runway and the likelihood of a near-term financing: a highly priced company needing cash within 18 to 24 months may warrant closer scrutiny than a growing business with several years of runway.

Endowments face continuing cash outflows and may become overallocated to private assets when public markets fall. Somerville says they are among potential secondary sellers, but family offices and pension funds also face liquidity or allocation pressures. The need varies by institution.

He expects some LPs to reduce commitment sizes and cut managers on the margin while trying to preserve relationships with their strongest managers. Keeping allocations constant may require a more concentrated portfolio; restoring an allocation later requires demonstrating value beyond capital, such as business development or secondary support.

Somerville expects LPs to examine whether managers realized public holdings when opportunities existed. He says distributed capital relative to paid-in capital, or DPI, becomes especially important when carrying values vary. DPI measures distributions; total value to paid-in capital, or TVPI, also includes unrealized value and can change with valuations.

Large growth funds may have substantial committed but undeployed capital. Somerville says he sees many managers waiting rather than investing rapidly and considers that discipline useful. Fees based on invested rather than committed capital can make patience easier for LPs, while fee terms and fund size affect alignment.

He thinks some growth funds became too large for near-term opportunities and expects more extensions or modest valuation increases rather than the rapid step-ups of the preceding boom. He allows that conditions may improve over time; this is his 2023 judgment, not a promise about later markets.

A strip sale can sell a fixed percentage across an entire portfolio, converting part of its value into distributions. In a tender offer a buyer offers a price to LPs, who may decide whether to sell. A continuation fund transfers assets into a new vehicle, often late in a fund’s life, allowing some investors liquidity while others retain exposure.

Stebbings asks whether a manager might seek a secondary mainly to show DPI and raise another fund, even when holding could produce more value. Somerville says the answer depends on the transaction: a tender gives investors a choice, a strip sale typically goes to an advisory board, and continuation vehicles need particular care to align interests.

Strip sales and tenders are generally simpler to arrange than continuation vehicles, in his account. He emphasizes matching the structure to the LP base and the manager. Optionality can help, but no structure automatically eliminates conflicts or makes a sale optimal for every investor.

Somerville says 2022 was a weak year for venture liquidity after an unusually strong 2021; he notes that a single quarter of 2021 exceeded all of 2022 on the measure he describes. He forecasts only incremental improvement in 2023, with more substantial improvement hoped for in 2024 and 2025.

He points to buyout and private-equity acquisitions, majority recapitalizations and secondary transactions as possible sources of liquidity. He does not expect a return to the prior boom in 2023. These are his forecasts at the time, not established subsequent outcomes.

In earlier markets StepStone often bought early shareholders’ company stakes and sought conversion into more recent preferred securities. Somerville says those terms could improve downside protection compared with common stock, which sits behind other claims. He also preferred businesses with approximately three to five years of runway.

As fund-interest opportunities expanded, he says StepStone’s activity became more balanced between fund and company secondaries. For an LP interest, the buyer studies the underlying companies: he prefers two or three assets to represent 70% to 90% of the value, accepting concentration rather than buying a widely dispersed portfolio.

He describes purchasing an interest at a 30% to 40% discount to the last round as a way to obtain lower effective exposure without forcing the company to conduct a down round. The discount is relative to a reference mark, however, and does not by itself establish fair value or ensure a profit.

Citing Jefferies industry data, Somerville recalls an average venture secondary discount of about 12% in 2021 and 34% in 2022. In opportunities he was seeing around the interview, fund interests were often discounted 30% to 45%, while company stakes were around 20% to 35%. The figures refer to different periods and samples, not guaranteed market prices.

He says larger discounts also exist, but quality, timing of the last round and other details matter. He sees selective opportunities rather than a reason to deploy indiscriminately. On company stakes he wants to understand runway, the cap table and securities that may rank ahead of the buyer at exit.

Somerville warns that a secondary buyer without management access or information rights may be underwriting with an incomplete picture. He looks for investors able to support the company, the age and resources of their funds, and existing or future liquidation preferences. Even apparent protections can change in later negotiations.

StepStone’s model, he says, uses existing relationships with fund managers to obtain introductions to company leadership, then adds its own diligence through customer calls and financial review. He presents those relationships as an informational advantage. His account also describes the commercial positioning of his firm.

To assemble meaningful company stakes from small sellers, Somerville prefers working with management, which may know which employees and early shareholders want partial liquidity. A coordinated transaction can consolidate several positions and give the buyer a direct relationship, rather than a series of opaque, isolated purchases.

He warns that LPs investing directly can face adverse selection and additional fees through special-purpose vehicles. A deal presented as a safe 2x may have higher pricing, greater burn or execution risk than expected. These are his underwriting cautions, not a claim that all SPVs or direct investments have those problems.

Somerville contrasts the 2023 market with 2008–10. In his example, selling a fund marked at three to four times cost at a 50% discount could still leave approximately 1.5 to 2 times cost before relevant adjustments, whereas earlier discounts could crystallize losses. These are illustrative arithmetic and depend on marks, fees and transaction terms.

Company sellers may be less patient than an endowment because former employees and individual holders need liquidity. He expects their willingness to accept a price to depend on their circumstances and prospects for an exit. That is a market judgment, not a verified timeline for any company’s IPO.

For managers considering secondaries, Somerville recommends consulting the LP base and evaluating each asset’s expected upside and price. He suggests that a manager might prune some exposure where the potential from the current mark looks modest, while retaining a larger position where conviction and potential upside are higher. These are illustrative judgments, not guarantees.

He predicts more international capital entering venture, especially growth funds, because newer LPs may prefer shorter duration and have large checks to deploy. Stebbings worries that families who entered at a high point and saw losses will leave the asset class. Somerville agrees some newcomers may be discouraged.

His proposed response is a diversified program across stages and vintages, combining appropriately sized early funds with thoughtful later-stage or secondary exposure. He believes less competitive vintages can offer opportunity, while his firm has a commercial interest in raising and investing in those strategies. Future vintage performance is uncertain.

Stebbings asks whether managers should sell an ownership stake in their management company to secure a fund commitment. Somerville expects more demand for such stakes but would generally avoid selling unless necessary. He warns that long-term carry arrangements, control and perceived preferential treatment can complicate future fundraising.

He expects emerging managers to face greater sensitivity to fees and carry. For slower-deploying growth funds, LPs may focus on fees charged on invested rather than committed capital; he sees a different situation for active early-stage funds. Terms and effects vary by fund.

On performance kickers, Somerville is comfortable with a simple step-up at an appropriately high threshold, mentioning at least 3x net and sometimes 5x or 10x. He dislikes overly complex tiers or low thresholds. These are his preferences as an LP, not market standards or achieved returns.

For a GP commitment, he says the manager’s contribution should be meaningful relative to personal wealth rather than mechanically fixed at an extreme percentage. Stebbings notes that requiring too much can force managers to recycle fees instead of investing in their team; Somerville agrees that the trade-off matters.

Somerville says his view of venture valuation policy changed as managers adopted more public comparables, option-pricing models and discretionary markdowns. He wants fund sizes to reflect realistic deployment opportunities and expects secondaries to remain an important complement to long-duration early-stage funds.

He identifies two difficult LP tasks: assessing whether reported TVPI reflects underlying value and understanding partnership dynamics. He predicts tensions may arise when established partners remain important for fundraising while younger investors seek more responsibility. He considers advance communication about changing roles important.

He criticizes funds returning to market after six to nine months during the boom, arguing that very rapid fundraising can leave several vintages exposed to the same conditions. Stebbings notes that differences in pricing across periods make vintage diversification more visible during a correction. Both are discussing risk, not realized performance for every such fund.

Somerville’s investment lessons differ by strategy. On funds he says he underestimated the effect a high-profile lateral hire can have on partnership chemistry. On companies, even selecting a category leader can disappoint when the category or exit multiples are weak. On secondaries, he warns that security structure and senior claims require careful analysis.

On emerging markets, he expects renewed emphasis on the US but sees different conditions across regions: continued interest in India, changing enthusiasm for Southeast Asia, currency considerations in Latin America and divergent opinions on China. These are his 2023 expectations, not a forecast of uniform outcomes.

Despite disappointment with excessive pricing and behavior during the boom, Somerville remains optimistic about venture as a source of innovation and technological growth. He says he intends to stay invested in the asset class. Stebbings thanks him for the conversation and his past support.