Venture capital investors
Just as there are good rationales for founders, employees and management teams to seek liquidity for their stock, there are several compelling reasons for a venture fund to consider a secondary transaction. In general, enabling more capital to be returned to limited partners (LPs) sooner is a good thing for the venture industry as a whole. In particular, it is logical for angel investors and early stage VCs to consider liquidity for some of their older portfolios as those
companies mature. Over the past decade, the time to liquidity for venture backed companies has increased dramatically from on average three years in 2000 to over nine years in 2010.
Since most venture funds have ten year terms, it is expected that direct secondary transactions will become an increasingly common means of achieving liquidity. Some examples of why a venture investor might consider a secondary transaction include:
Return cash to limited partners – While many venture capitalists view themselves as company builders and take seriously the obligations that they have made to the entrepreneurs and companies in which they invested, venture capital firms have a primary responsibility to their limited partners. In today’s challenging economic environment many firms find themselves having not returned capital to their LPs in the seventh or eighth year of a fund. When a firm finds itself in that situation, selling some or all of its holdings to a secondary investor is a sensible way to provide liquidity to their LPs and to ensure
continued support for the companies they help start and fund.
The firm’s expertise is investing in early-stage companies and its value-add is
decreasing over time – Venture capitalists generally acknowledge that some CEOs are better suited for start-ups and other CEOs are more appropriate for mature companies; however, they struggle to accept that some investors are better suited for early stage investments, but inexperienced in managing later stage private companies. While some investors can effectively manage a company over its different stages of development, many others would be better off refocusing their efforts on companies where their skills can provide the greatest value. A secondary transaction can be an effective means for general
partners to best match their expertise with the appropriate companies in their portfolio.
The fund is over eight years old – A direct secondary transaction can help facilitate the orderly wind down of a fund that has come to the end of its life. It allows the general partners to provide cash returns to their limited partners, who would otherwise be left holding illiquid assets, and avoids the need for fund extensions or annex funds which frequently come with unattractive terms for the general partners and earlier LPs.
Refocus the time and energy of the general partners – A direct secondary transaction can free up general partners to devote their time and energy to more recent funds and focus on new investments.
A portfolio company needs more money and the fund has no more reserves – In today’s environment, venture capital firms frequently find themselves unable to provide necessary follow-on financing to all of their portfolio companies. Particularly in “pay-toplay” situations, a sale to a new investor, with reserves and a willingness to invest in a follow-on round, may maximize the value of the investment for both parties and helps the company raise sufficient capital to accomplish its growth objectives.
The partner who made the investment has left and the fund’s focus has moved to other industries or sectors – The venture capital landscape is littered with stranded investments due to changes in fund strategy, industry focus, or partnership dissolutions. A secondary sale of “stranded” investments can often provide attractive returns for those positions that would otherwise wither away unattended.
The fund has a different view than the board or management about the direction of the company – In late-stage companies, when investor syndicates can often be quite large, not everyone will always agree on the future course of the company. In many cases, finding a secondary investor more aligned with the majority view on the direction of the company can be an effective means to resolve those differences while allowing for a graceful exit of an investor that played an important role in the company’s early development.