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Venture capital firm G Squared was founded with one idea in mind: venture-backed companies are staying private longer. And with the IPO market now frozen over, that thesis is proving true.

In the latest episode of "In Visible Capital," G Squared founder and managing partner Larry Aschebrook checks back in with PitchBook senior editor James Thorne to discuss why his firm is pressing pause on the secondary market as primary investors load up deals with downside protection, and what those protections look like in an uncertain market.

Aschebrook also touches on the consolidation of capital with consistent GPs, the uncertain future of the SPAC market, and how founders are coming to terms with the current fundraising environment.

Plus, PitchBook lead analyst Nalin Patel chats with host Alexander Davis about insights from the Q3 2022 European Venture Report and 2022 UK & Ireland Private Capital Breakdown.

In this episode of Sapphire Ventures' series "GameChangers," Sapphire partner and Head of Revenue Excellence Karan Singh speaks with Unity Global VP of Sales Laura Palmer about how to solve real problems in a category creation environment. Laura will speak to how she drove her teams toward business outcomes and use cases to bring theoretical concepts like the metaverse into practical reality, both in her tenure at Google and now at Unity.

Listen to all of Season 6, presented by Sapphire Ventures, and subscribe to get future episodes of "In Visible Capital" on Apple Podcasts, Spotify, Google Podcasts or wherever you listen. For inquiries, please contact us at podcast@pitchbook.com. Transcript James Thorne: Larry, I was looking back at my calendar. It seems like it's been about a year and a half since we last spoke. It was early 2021. A lot has happened since then.

Larry Aschebrook: It's been an interesting time both in the public and private markets. Lots has changed.

James: Especially for you all. I know G Squared sits at that latest stage of venture-backed companies. I think you guys were founded with the premise that as companies stay private for longer, [that] creates liquidity challenges for investors, for founders, for employees. We're now in this position where going public, getting liquidity, is especially difficult. How does your firm's role in the market change when the markets turn south?

Larry: I think that it's more challenging to navigate certain scenarios in which we're interested in deploying capital. As you and I talked about a year ago or so, we founded the firm based upon the idea that companies would continue to stay private longer. That thesis is definitely playing out. For a while there it looked like it was going to go the opposite direction, but now businesses—obviously, with the IPO window being closed—are likely to continue that trend that's been pretty consistent over the past decade.

However, today, ... [there's] uncertainty around where the public comp multiples are going, and all of the folks know that that's really how we underwrite the assets, ... based upon a certain set of public comps and then discounted back, apply some discount rate, but you essentially use the public counterparts as a measurement of value. With that being very uncertain on what those look like in the medium term, the secondary component of our strategy temporarily becomes a little bit less interesting for us, and [we] switch to be more of a primary investor.

The reason behind that is, given the amount of structure that's going into the primaries today, the ones that are being done, regardless of the top line valuation number that's being stated, for the most part, most of the deals we're seeing happen have some type of downside protection in them. The discounts on the secondary market become less attractive because of the structure of new equity on top of the preference stack.

Right now, on the secondary market, which is a major piece of our strategy historically, we tend to pause and let this segment of structured equity flow through the businesses globally and let them get their rounds solidified and their balance sheets shored up, and then really understand what the company's capital structure looks like before we head back into [the] secondary market and hunt for those interesting opportunities on a dislocation of pricing and intrinsic value.

I would say that's the major thing that's changed for us over the past year. Today, we're basically not deploying capital without some type of downside protection into the equity that we're buying.

James: I just recently actually talked to Brad Feld, who wrote "Venture Deals," who talked about all the kinds of protection that investors might be seeking at a time like this. Obviously, we're not in 2001. We haven't seen things fall quite that badly. What are the kinds of protections that investors like yourself are demanding from portfolio companies in rounds today?

Larry: I think it varies depending upon the maturity of the asset. You made a comment before about G Squared being a later-growth investor. I think for us, we view ourselves as a growth investor that tends to lean toward the more mature-growth businesses because of the increased likelihood of some degree of outcome that's positive, of course based upon pricing.

Most of the assets that we're dealing with today are in two groups. One is they're at the early stage of their growth cycle and so layering a significant amount of structure on the equity could potentially be damaging to that asset in the long term, from the ability to raise more capital.

Then the other section, or group of companies, are the ones that are very mature [and] would probably likely be public today if the IPO window or the IPO market was robust. They're looking to shore up their balance sheets, not necessarily because they need to, but because of the uncertainty ahead until the timing of potentially reaching the public markets.

The structure in those two types of companies are very different, and depending upon the circumstances can be much more traditional with maybe some anti-dilution protection on the purchase on the earlier-growth businesses, to the later-growth stage businesses where you're seeing a lot of multiple preference, like a 2x preference and then also some embedded IRR hurdles that last in some cases through IPOs for a certain period of time.

Really it depends for us. Those are really the two types of businesses that we're focused on at G Squared. It just depends on the situation, but those are some of the types of structure that's being put on it. Regardless of the headline valuation that's printed in the more mature-growth businesses, it's really about the structure around the preference and any embedded IRR hurdles that we're able to achieve.

Then [in] earlier-stage growth businesses, [it's] about embedding some anti-dilution protection for future rounds that potentially will raise at a lower price than maybe the stated valuation on the current round if multiples don't expand, and that's where you can embed protection.

James: At a high level, how do you feel like the needs of companies have changed from 12 months ago to today, from a capital raising perspective?

Larry: I think that the needs probably haven't changed that much. I think that the way the equity looks like going in looks a lot different today. I think businesses continue to need more capital to grow and the control of what that looks like has been returned to investors, I think is the major change. Because before you might have passed on a lot of companies because of pricing. Today, those same businesses, maybe you are willing to invest in because the terms are different. Not necessarily down rounds, but there's protections embedded in the paper.

I think the difference is actually what the companies are willing to accept to receive the capital. Not that they don't need the capital. I think that the majority of growth businesses still need that capital for growth, because if you sacrifice growth at all costs to lower burn, it's very difficult to make up for that lost time.

If you have a business that's traditionally growing at, in many cases in our portfolio, several percentage points month over month, if you sacrifice that for a long duration to save capital and lower burn, you're long term harming that business. If you believe in the underlying business itself and the economics and its ability to eventually be profitable—or if it's teetering on profitability even—sacrificing growth at all costs today isn't, in our opinion, the right thing to do. The companies are better off taking capital at maybe more manager-friendly terms to continue the growth path.

James: In your conversations with founders, how have they been handling that transition? We're coming off of the most founder-friendly period in history, potentially. It's reversed fairly quickly. Are they for the most part managing that transition pretty well?

Larry: I would say today versus four months ago, they're managing it better. I think there was this perception broadly among founders that the multiple compression was likely temporary. They're not worried about the public markets because they're growing a business for the next several years that's going to be a private business, and that the multiples will return to what they once were.

I think that that was a difficult thing for entrepreneurs to accept, that the current status that we're in now is likely a longer duration than what they might have hoped for. It's taken some time for entrepreneurs to reconcile that, and in the growth investment community and just broadly the private capital community, I think the education for the entrepreneurs around this topic has been helpful and healthy for the asset class.

You need to really take a pragmatic approach to fundraising and ultimately be about the end goal and not necessarily about maximizing what the value of your business is today. I think that they're starting to get there on the company side.

On the secondary market, the owners of shares that need liquidity are still hoping that multiple expansion happens and we're not seeing significant activity. We're seeing some, but not as much activity as we've seen in the past on the secondary front, because the sellers don't like the current pricing. In most cases, managers have time on their side to wait, and in the situations where they don't, then there are some compelling kind of discount-to-intrinsic-value opportunities out there and really high-quality businesses.

[For] both kind of companies—as well as other managers who are looking for liquidity, especially the early-stage managers who have such low-cost basis—there's been a bit of a process for people to wrap their heads around the current environment.

James: If we assume that multiples remain more or less where they are today, how long do you think that it will take before you start to see more of those discounts making their way into the secondary markets? ... Does the lack of exits—and therefore returns to LPs, the decline in those returns—does that accelerate the need for selling assets at a discount on the secondaries markets?

Larry: Yes. Our thesis is that we probably live in this cycle we're currently in for the next few quarters, at least, if not maybe the next 18 months. We also think that mid-June, the Nasdaq was pretty close to maybe the theoretical bottom. Maybe it gets back to where it was in early pandemic time, but you're only 15% off of that from the June lows. Part of the digestion of the new multiples is, how long do you believe that they'll stay in this range.

Sellers, depending upon where they own the asset, as time goes on, will value liquidity over maximizing price. I think we're still at the early stages of that. I don't anticipate there being this overwhelming run for the exits from early- and mid-stage managers, or even growth-stage managers, for liquidity in this calendar year. If the public markets continue and the multiples continue to be compressed for the next year, then you're into it for kind of 18 months in total. Then we could see a significantly more robust secondary market.

Growth managers especially are trying to understand where the companies are going from a valuation perspective from your peers, and over time that multiple either stabilizes, compresses or expands. Most of us are in the same boat of where we don't really have confidence in which direction that that's going.

Being patient is important in the secondary market. Until you understand all the structure that's going into the asset class, it becomes less exciting, because even if you have a terrific discount to an asset that recently printed a valuation of a few billion dollars, and you have a 50% discount on some early-stage shares, but that money at a few billion dollars went in with a 2x liquidity preference and an IRR hurdle. Your 50% discount of the stated price is far less attractive than just participating in the primary.

It takes a little time for that to get all teased out before the secondary market becomes a really interesting place to jump back in with both feet.

James: One thing that we've seen is a number of companies slashing 409A valuations, doing that primarily to sort of help with employee retention now that the value of options and RSUs are falling. Obviously, the labor market is really tight still, and there's no real clear path to liquidity in the near future at least. What can companies do to alleviate some of these challenges? What role do firms like yours or the secondaries markets play in that kind of strategy?

Larry: The 409A valuations that are being publicly announced, you've seen a few of them out there. It's really like what you mentioned, employee retention exercise, and/or to help attract talent. I think from a secondary market side, it's a good data point to try to negotiate a lower price on stock, especially if it's common stock that you're trying to purchase. That could be helpful in finding opportunities that are discounted to intrinsic value.

I would not be surprised if you see some more of that as time goes on, as companies layer equity on increased cost of capital through structure. I would imagine that 409A valuation firms are going to subscribe maybe a lower price or lower valuation to the common shares, employee shares. I think it's too early to really understand the trend there from our perspective, but it's something we're paying close attention to.

James: Something we've been hearing a lot more about is alternative sources of financing, things like structured equity, revenue-based financing. You've obviously been talking about adding structure to equity deals. How big of a role do you think that these alternative sources of financing will play in the venture ecosystem going forward? Obviously, they've been kind of a minor piece of the puzzle in the past.

Larry: Yes. I think today they're a lot more relevant than what they've been in recent history. I think it's situational. I think companies that are significantly well currently capitalized, but want to put additional capital on their balance sheet, might look to some of those alternative structures as being far less costly than some of the things we've been talking about today from a cost of capital standpoint and has a little bit of flavor, maybe like some later-stage venture debt, with combination of maybe some equity and some debt with some embedded return hurdles on that equity.

The earlier-stage businesses, the investors will be very leery about structured products that put preference above theirs on the companies and would rather figure out ways to continue to fund them through more traditional equity sense with potentially some downside protection and anti-dilution, versus putting debt on a business that still has significant amount of capital to raise in the future.

Obviously, there's the French examples, where it's a small amount of debt in a very large business, or a large amount of debt on a very large business. Depending upon where they are in their life cycle as a firm, debt can play a major positive role in the business if it's the right business. I think it's situational and it's definitely more active today. I've talked to several firms that are active in the space and they're looking and asking if there's any needs in our portfolio.

They're seeing an opportunity like others are, when there's times of volatility and uncertainty, oftentimes there's opportunity and disruptive business models, like the structured equity folks who have the flexibility of doing debt and equity with reasonable return hurdles, can be attractive. They'll continue to play more of a role here in the interim, as we try to figure out where the world's headed.

James: We've been talking about companies and investors, but I'm wondering if we could look at the other side of the equation. Obviously, GPs have been raising huge amounts of capital since 2020, this first half of this year. It looks like we're on our way to set new records. Are you starting to see that change based on your conversations?

Larry: No. I think that that's still the same. We're like most other large growth managers, where we're basically on a perpetual fundraising cycle every couple of years. The appetite by LPs to continue to get access to the space remains robust. I think that the new vintage funds, the 2022 vintage funds that are put in place, being this year now and in the latter part of this year, will have the opportunity to likely be some of the better outcomes in our asset class than in the past multiple vintages.

If you look back in history and look at the returns of funds that were raised following 1987 or '99 or 2008, the funds that followed those periods are pretty much every manager's best-performing funds than any vintage they've ever had. I think that's what the LPs are anticipating, and what the managers are seeing. That's why I think in 2022, you're seeing just as much money flow back in from a capital race standpoint, for the most part as you did in the prior years. If not, I would not be surprised by the end of 2022, if it actually surpasses the prior year, just based upon the opportunity set that we all anticipate is in front of us.

James: I think one of the things that that capital raising environment, the question it raises for me is, how do you balance if you're an LP? You've got all this cash going out in the near future. You're not going to see a lot of it coming back in. Are LPs putting pressure on GPs to slow the deployment of capital or to take steps to manage their returns that they're still seeing? The LPs are still seeing some capital coming back to them?

Larry: Yes. We're hearing that from LPs of course, like, "We believe in the strategy, we believe in the opportunity set. What's the capital call schedule look like?" At G Squared, we're in a unique position because of just the thesis behind our funds, where essentially our funds, the capital comes in and comes out relatively quickly, just with our thesis and so our LPs today can fund the capital calls of the current fund with the proceeds of the fund from two funds ago.

I think one of the items that external community probably doesn't fully appreciate that the LPs are experiencing is if they have a long-term relationship with the manager and that manager has performed over time, that the earlier funds that they funded, they're still getting distributions from those funds to fund net new capital calls.

I think if we were trying to build our business today and go out and look for a bunch of new LPs that didn't have the history with this, of having that return of capital every few years, it would be much more difficult to build a growth-stage manager today from the ground up. I know there are first-time funds out there doing it, but doing it at scale I think would be a challenge just based upon what you're mentioning, which is when it's an LP with a new relationship. I put my money in today, how long before it starts to come back out? Versus I'm an LP and a handful of managers that've been in for the last decade and I'm in six funds with them and I know that I'm getting return capital from the prior funds. I'll re-up for this one.

It's the known quantity versus what's the unknown. I think that's why you're seeing existing managers come back to the market so frequently, because their LP bases are really narrowing the fund managers they're in. That's why continued terrific performance as a manager is your lifeblood. You have to do everything it takes to make that happen. It's continuing to become more and more challenging to live up to those things. If you're a manager that could do that, you'll always be able to raise money regardless of the economic cycle you're in.

James: Yes, we've definitely seen that kind of concentration of power. A lot of money going to a handful of firms and new managers struggling to raise funds for the first time.

Larry: The ones that are raising a fair amount of money are smaller funds. I'm obviously an LP in our funds, but also in other managers. Some of the smaller ones seem to raise a fair amount of capital relatively easily. It's the funds that are in the middle range that don't have a long history, haven't had a recycling of capital at least once, are building their business, that from talking to the market seem to have a little bit more of a challenge regardless of their performance. In some cases, performance is fantastic and in other cases it's average.

Obviously, [for] the ones that have terrific performance it's going to be easier than average, but if you're an established manager and you've had repeat performance for your LPs and you're doing what you say you're going to do and you have repeatable performance every fund—beginning of the pandemic, we raised the fund, raised a fund now—if you're able to have that repeat performance that people can count on and the stability there, managers can raise capital. That's why you're seeing the concentration that you mentioned.

James: There's obviously been a lot of turbulence in the SPAC market. I know G Squared launched a couple of SPAcs. I'm just wondering what your perspective is on that space and if you can see it making a comeback in the future?

Larry: The SPAC market, like anything that has overexuberance, has a pretty rough ride to the bottom. I think that that vehicle took off and probably a lot of people who shouldn't have put them together were able to raise money around it and there's been some pretty horrific performance of the companies that were taken public via SPACs and with interest rates being low at the time, it was a great way to make a yield.

I think a lot of the SPAC sponsors misunderstood the exuberance around the specific vehicle, to be that this could be a viable equity path for investors to invest in more companies and taking them public. It really, at the end of the day, was about very large institutions and hedge funds being able to get yield. With interest rates rising there's yield to get elsewhere so it's becomes far less attractive. With that said, SPACs have been, and I think will continue to be, a viable way for the right type of company to access the public market.

Our experience with SPACs at G Squared is I guess, still yet to be determined. But I think our thesis around it remains the same, which is albeit SPACs or traditional IPOs, our strategy lends itself to basically trying to provide entrepreneurs with capital through the transition of their business over time as they grow. Through the secondary market to help alleviate stress from an early-stage shareholder that needs liquidity, to helping employee retention with stock tenders, to providing growth capital and primaries really to push forward their mission. Then also to help them transition into the public markets, albeit participating in their IPOs, and/or for us, the SPACs was just a natural extension of that, which was to provide some of our best assets with more growth capital to transition to the public markets.

Our SPAC thesis came with and has lots of capital behind it. We target our own portfolio companies. Is it a viable instrument going forward based upon the pain that so many have experienced over the last year? I think only time will tell. I think our strategy around supporting entrepreneurs through their life cycle will continue. Before the SPACs it was through participation in IPO and during the SPAC craze, it was still participation in IPOs, and after it, it will still be participation in IPOs to help growth stories.

If the SPAC is a part of that, that's great. If not, it's okay for us. I think generally it has a place in the market to help a certain type of business access the public markets. With all of the issues around the SPACs, I would not be surprised that some of the benefits to use the vehicle go away because of all of the, I would say, C-rate and D-rate companies that were able to get public via SPACs and the harm that it caused a significant amount of shareholders that lost money.

I think some of those things are like being able to provide very clear forward projections, and having complicated business models, and benefit to being public probably at a younger age than a more mature age. Some of those things that really benefited companies by thinking about a SPAC, I would not be surprised if regulation made that piece of the SPAC far less available to companies. If that goes away, why not just go public via the traditional offering? I think that's really the question that's yet to be understood. Then that will determine whether or not they're viable platforms on a go-forward basis.

James: How interesting is M&A as an opportunity for you all to exit portfolio companies? Are you dead set on exiting via IPO or do you also look for strategic opportunities to sell?

Larry: Our thesis typically doesn't predicate well for the companies to M&A exit, because for the most part, where we concentrate our risk is in businesses that are massive multibillion-dollar type companies. When you start getting companies that are at the later stages of their business life cycle, we might have invested in them at their early growth stage, then they become a $10 billion-plus private company, the opportunity for somebody to come out and acquire them is far less likely than maybe a traditional portfolio of a growth-stage manager, where you have a bunch of $100 million to $500 million business from valuation perspective sitting in it where there are terrific acquisition target.

For us, it's far less of an outcome opportunity to have M&A targets in our portfolio. Our companies tend to be the ones acquiring those other companies, which on that side of things, it's very attractive right now. Some of the capital and the primary side that we're providing to companies, the use of proceeds is for M&A using current multiples to the advantage, to go out and acquire a business, because if you can acquire something today at a lower multiple but that provides a significant value add, where instead if you acquire it at 2x multiple or 3x multiple, that you can generate a 5x type of outcome on that for your business or from a multiple expansion perspective, you're able to have the appreciation of the assets, plus multiple appreciations that we expect in the future, and that becomes very powerful in the value creation for the shareholders of the business that's doing the acquiring.

We do have [M&A], obviously it's not the norm. It's not abnormal for us in every portfolio of companies that we have to have one or two that are acquired, but for the most part, our businesses are the ones that are doing the acquiring.

James: That's interesting. Yes, we've seen definitely a lot of consolidation especially in the crypto space lately, it just seems like that there's been a ton of M&A activity. Are there any other sectors that you see as especially ripe for this kind of private market M&A? Large startups acquiring smaller ones?

Larry: Yes. I think the mobility and logistics sector is ripe for that. I also think you'll see a fair amount of consolidation in the quick commerce space in the near term. The other strategies we're in are SaaS and consumer internet. They're always having very robust M&A markets in their industries. I would say the two areas, some of the consumer internet businesses, as well as the logistics and mobility 2.0 businesses that we invest in, are seeing a lot of M&A activity.

James: This is probably outside of your scope but we've seen quite a lot of interest in take-privates lately. I'm just wondering if that's anything G Squared would ever consider getting into.

Larry: We probably will stay in our fairway, so to speak, and just focus on building fund after fund to return the profile that our LPs expect, but yes, I do think that there are some interesting take-private opportunities in the public markets today. As well as I can appreciate why the PE folks are super excited about what's currently happening with their M&A roll-up strategies. I imagine they're very busy right now. Talking to the law firms out there, they went from chasing their tails on equity financing perspective to now the M&A market's pretty hot for them. The one thing that seems to be consistent is that the lawyers are doing well, no matter what's happening. [laughs]

James: Oh, that seems to be the case.

Larry: I don't think you'll see us do that anytime soon. We are very focused on not having style drift and just want to do the work and support entrepreneurs that are building the world's next great revolutionizing tech business. That's going to change the antiquated industry and have $10 billion-plus market cap potential, and that's what we're searching for, so we have our hands full doing what we're doing before we decide to do anything else.

James: Absolutely. Well, Larry, thanks so much for joining me.

Larry: It's been great. The year since we last caught up has been different and I'm sure a year from now, we'll be able to come back to this call and see how right or wrong we were, and I look forward to keeping in contact. Thanks for having me.

James: Thank you. In this episode