In recent years, the landscape of venture capital has undergone significant transformations, particularly within the realm of deep tech. As startups increasingly remain private for extended periods, the secondary market has emerged as a crucial avenue for liquidity, especially for early investors seeking exits. This shift is not merely a trend; it reflects deeper dynamics at play in the investment ecosystem, driven by technological advancements, changing investor expectations, and evolving market conditions.
Sriram Viswanathan, founding managing partner of Celesta Capital, a San Francisco-based venture firm specializing in deep tech, offers valuable insights into this phenomenon. With over a decade of experience in the sector and a portfolio that includes notable exits such as Credo, Habana Labs, and Innovium, Viswanathan is well-positioned to discuss the implications of the burgeoning secondary market for deep tech companies.
The current investment climate is characterized by an influx of capital chasing a limited number of high-quality deals. This imbalance has created a competitive environment where investors are increasingly turning to secondary transactions as a means of gaining exposure to promising ventures. The surge in interest is particularly pronounced in sectors like artificial intelligence (AI), healthcare, and data center infrastructure, which have seen unprecedented growth and innovation.
Viswanathan notes that the current market resembles a pendulum, swinging between periods of abundant capital and times of scarcity. Presently, we find ourselves in a phase where capital is flowing freely, largely fueled by advancements in AI and the ongoing buildout of data centers. This influx of investment has led to a scenario where fewer viable companies are available for funding, prompting discerning investors to seek greater exposure through secondary markets. Early-stage venture capital firms, traditionally focused on mergers and acquisitions or public listings as exit strategies, are now increasingly engaging in secondary transactions, which have become a significant component of their liquidity strategy.
Historically, secondary markets have been dominated by larger institutional investors seeking proven business models and predictable cash flows. These players typically operate with different return expectations compared to early-stage investors, who are often more willing to take risks on unproven technologies. However, the dynamics of the secondary market are shifting, particularly in the context of deep tech. Investors are now drawn to the potential of category-defining companies, especially in the AI space, where the focus has shifted from immediate revenue generation to long-term market dominance.
This change in perspective is evident in the way investors evaluate opportunities in the secondary market. Rather than prioritizing traditional metrics such as cash flow and revenue growth, many are now assessing whether a company has the potential to emerge as a “winner” in its category. This approach aligns with the broader trends observed in the AI sector, where a few dominant players are emerging, and the competition is fierce. The landscape is reminiscent of the early days of the internet, where a handful of companies captured the majority of market share, leaving little room for others to thrive.
While the enthusiasm surrounding AI and related technologies is palpable, Viswanathan cautions against the risks associated with overbuilding. The rapid expansion of infrastructure to support AI and data center capabilities may outpace actual demand, leading to an oversupply situation. Larger players, such as hyperscalers and established cloud providers, may be able to weather the storm, but smaller companies could face significant challenges if they cannot adapt to changing market conditions. This potential for overcapacity underscores the importance of maintaining a balanced approach to investment and growth.
The prolonged hold periods experienced by many startups are reshaping the behavior of limited partners (LPs), general partners (GPs), and founders alike. In an environment where investors are increasingly impatient for returns, the demand for distributions has intensified. The concept of DPI (distributions to paid-in capital) has gained prominence, with many investors viewing it as a critical metric for evaluating fund performance. As a result, secondaries have become an essential tool for meeting distribution expectations without relying solely on traditional exit routes like IPOs or mergers and acquisitions.
The current state of the public markets also plays a significant role in shaping investor behavior. Over the past several years, the public markets have experienced remarkable growth, creating a sense of urgency among investors to see similar returns in their private investments. This dynamic has led to a greater willingness to engage in secondary transactions, as LPs and GPs seek to capitalize on favorable market conditions while also addressing the liquidity needs of their portfolios.
Despite the excitement surrounding AI, Viswanathan emphasizes the need for deep tech companies to return to basics. While cutting-edge technology is undoubtedly important, it is not sufficient on its own. Companies must demonstrate tangible progress in terms of revenue growth, margin improvement, and scalability. The lessons learned from the software-as-a-service (SaaS) boom serve as a cautionary tale; during that period, companies were often valued based on lofty revenue multiples, only to see those valuations recalibrate as the market matured. The same scrutiny is now being applied to AI companies, with investors increasingly demanding evidence of sustainable growth and profitability.
Beyond AI, there are several other areas within deep tech that are garnering attention from investors. Biotech, for instance, is experiencing a renaissance, driven by advancements in genomics, personalized medicine, and drug discovery. The convergence of biology and technology is creating new opportunities for innovation, particularly in fields such as diagnostics, therapeutics, and medical devices. As the healthcare landscape continues to evolve, the integration of AI and advanced analytics into these sectors is expected to yield transformative results.
Viswanathan identifies three broad categories within deep tech that are particularly promising. The first encompasses hardware systems, intelligence, and infrastructure, including the physical components necessary to support AI and data center operations. This sandbox extends beyond AI itself, encompassing a wide range of technologies that enable the development and deployment of intelligent systems.
The second category focuses on the software layer, which includes AI tools and applications that leverage advanced algorithms to deliver value across various industries. This area is witnessing explosive growth, with applications spanning healthcare, retail, supply chain management, and more. The ability to harness AI for practical use cases is driving demand for innovative software solutions that can enhance operational efficiency and decision-making.
The third category involves the intersection of biology and technology, where advancements in robotics, surgical capabilities, and diagnostics are reshaping the healthcare landscape. The miniaturization of complex systems, such as imaging equipment and diagnostic tools, is enabling more precise and efficient medical interventions. As these technologies continue to evolve, they hold the potential to revolutionize patient care and improve health outcomes.
As the deep tech ecosystem continues to mature, the interplay between investor expectations, market dynamics, and technological advancements will shape the future of venture capital. The rise of the secondary market represents a significant shift in how investors approach liquidity and exit strategies, reflecting the unique challenges and opportunities inherent in deep tech investing.
In conclusion, the growing importance of the secondary market for deep tech investors underscores the need for adaptability and strategic thinking in an ever-changing landscape. As startups navigate prolonged hold periods and evolving investor expectations, the ability to leverage secondary transactions will be crucial for achieving liquidity and meeting the demands of a diverse investor base. Ultimately, the success of deep tech companies will hinge on their ability to demonstrate sustainable growth, profitability, and a clear path to market leadership in an increasingly competitive environment.