Stop Asking About Discounts: Why Asset Quality Drives Venture Secondary Returns

Returns in the secondary market are typically driven by two factors: asset appreciation and discounts. Let’s face it, everyone likes a discount. Purchasing a big-ticket item at 25% off is appealing!

It’s human nature to strive for the best value and bargain hunt. However, in the venture secondary world, we have found that higher discounts are not correlated with better returns nor do discounts materially contribute to returns. This is evident in our own portfolio.

As shown in Figure 1, fund secondaries acquired at discounts of more than 15% have actually materially underperformed those acquired at thinner discounts.¹ As we jokingly say, buying junk on sale doesn’t make it less junky. Rather, we believe the secret to success with venture secondaries is gaining concentrated exposure to the asset class’s most elite companies at reasonable valuations.

Figure 1 | Inverse relationship between discount and performance
 

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Fundamentals of venture capital

To better illustrate why this is the case, we first unpack some of the fundamentals of the venture asset class. Data suggests that, over the last 10 years, the top 100 exits drove 45% of the realized returns in venture (Figure 2).²

Figure 2 | Outsized exit value driven by top VC-backed companies
 

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Source: Felicis Ventures

The top 100 exits had a collective market cap of $1.7 trillion at the time of their respective exits.³ This proves a few simple truths about venture:

1. Venture is a winner-take-most market;
2. The best companies compound for years to reach massive terminal value; and
3. Exposure to outliers is everything—median venture capital returns are mediocre at best.
 

Median-performing companies have a muted impact on fund returns. Companies which exited for between a 1.5x and 2.5x multiple on invested capital accounted for only 9% of the cumulative returns of mature venture funds.⁴ Exposure to those assets via secondary transactions, even if acquired for a meaningful discount, clearly does not impact returns. Insights from SPI by StepStone suggest that outperformance in venture, particularly at the later stages, stems from a manager’s ability to concentrate capital in winning companies.

• Among late-stage funds which spread >80% of invested capital across more than 10 investments, only 3% have generated a TVPI greater than 3x.
• Conversely, 24% of late-stage funds which concentrated >80% of invested capital into less than 10 companies have generated a 3x-plus TVPI.⁵

Concentration is key

With all this in mind, we’ve embraced a simple philosophy. We believe concentration is better than diversification. Initial IRR pops from discounts can often be smoke and mirrors; end-of-day multiples should be the sole focus.

A recent fund secondary transaction exemplifies our approach. About six months ago, we acquired an interest in a seed-oriented, cybersecurity-focused fund. The fund’s top three assets represented roughly 60% of record date (6/30/2024) net asset value (NAV). The most meaningful company by NAV was one that we categorized as a “Best Idea.” We reserve that designation for category defining companies with best-in-class products, operating metrics, and management teams.

To be considered a Best Idea, we must also observe clear buy signals from our fund managers—e.g., investing above pro-rata to increase ownership in subsequent financing rounds, crossing the company over into a later stage fund series, and/or highlighting the business as a value driver publicly. This company grew from $0 to $50M in Annual Recurring Revenue (ARR) in just three years and is on pace to triple its ARR by the end of its fiscal year.

When both quantitative and qualitative conditions are met, we actively hunt for exposure to these Best Ideas, irrespective of structure. In the case of this company, we not only gained meaningful look-through exposure via the fund secondary, but we also participated in its Series D financing round, which came together just before closing the transaction. More recently, we co-led its Series E financing round, which was completed at a roughly 3.5x step-up to the valuation associated with the company in the secondary transaction.

The next two largest positions were companies that we had deemed Highest Conviction Targets (HCTs). While a notch down from “Best Ideas,” we still believe HCTs are among a select group of venture-backed companies with multi-billion dollar exit potential.

All three of the top companies were backed by at least three of our fund managers. This afforded us deep insight into their financial performance and multiple reference points to stress test their market position and ability to sustain hyper growth. Initial diligence and reference checks gave us confidence that the current carrying value of these positions was likely a fraction of their terminal value. We closed the deal at a 6% premium to record date NAV. Factoring in the valuation of the financing round raised by the most meaningful company, the pro-forma discount was around 23%. Despite paying a premium, we believe this secondary will outperform our 2.5x underwriting target, with upside well beyond a 3x.

What about direct secondaries? 

We believe securing a discount is even less important with direct secondaries (i.e., acquiring shares directly from a company’s shareholders). Discounts are pegged to the valuation of a company’s last financing round. Many later-stage venture-backed companies raise rounds infrequently or stop raising altogether, yet still grow rapidly, while reducing burn or turning a profit.

Our meaningful investment in a direct-to-consumer pet brand helps illustrate this point. The company last raised a primary financing round in 2022 at a current year revenue multiple of around a 5.5x or a forward year revenue multiple of ~3.2x. We secured shares in the company from an early investor in mid-2024 at a 70% premium to the valuation of the 2022 round. At first glance, a premium this large may seem irrational. But, if you consider the valuation on a relative basis, it becomes clear that it was a very attractive entry price. We paid 2.8x current revenue or 2.1x forward year revenue for a business that had more than doubled its revenue and turned profitable with meaningful EBITDA. For reference, the company’s closest public comparable has had a market capitalization of $4–6 billion in recent quarters and trades in a current year revenue multiple range of 3.5‒6.0x. The public comparable is growing materially slower, has an inferior revenue model, and is less profitable. So, despite actually paying a “premium” on the transaction itself, we would argue that our process of underwriting quality and emphasizing company performance has, in effect, allowed us to get a very attractive entry price on a first class asset.

Conclusion

Discounts can be used as a tool to enhance returns, but the conventional narrative for venture secondaries deserves rethinking. In our view, chasing bargains in venture is a fool’s errand. Venture has been and will always be a market in which a small number of companies produce a disproportionate amount of the returns for the industry. With that in mind, we encourage the LP community to shift the conversation away from discounts and toward quality, identification, access, and long-term performance. All of this is to say: don’t worry so much about what’s on sale and focus more on what’s worth buying!

1 Performance as of September 30, 2024. Represents closing discounts for fund secondaries across mature StepStone VC Secondaries funds. 
2 Felicis Ventures and SPI by StepStone.
3 PitchBook as of May 2025. 
4 SPI by StepStone. Represents data from over 10,000 realized investments from funds with a vintage year of 2020 and prior. 
5 SPI by StepStone. Represents data from late-stage funds with vintage years 2018 and older, with performance data as of September 30, 2024. Excludes healthcare specialists and corporate VC funds. 

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