Other ways to exit from Venture Capital investment
“Knowing when to exit a trade is much harder than entering a trade” -Nial Fuller
2020 was a great year for some investors who saw exits from their investments in startup. For example, at the end of 2020 Postmates (food delivery company) was acquired by the giant Uber for +USD$2.6bn, this transaction was made with the aim of expanding Uber’s presence in the food delivery market while its transportation business was severely affected by the pandemic. Postmates investors such as Founders Fund, AngelPad, Spark Capital, Harmony Partners, Tiger Global, Blackrock and GPI Capital received an attractive amount for their share in this successful exit.
Also in 2020, Doordash investors such as Khosla Ventures, Sequoia, Kleiner Perkins, Softbank Vision Fund, DST Global, Temasek, T. Rowe Price and Durable Capital Partners had the opportunity to list the company on the stock market and thus be able to carry out the exit of their investment at a valuation of more than USD$60bn by the close of the first day of its listing.
Undoubtedly an acquisition or a public offering in the stock markets are the main outlets for investors in VC. However, there are other strategies that can be used by investors to get their investment back and potentially have a financial return. The main strategies are:
- Secondary market
Almost every startup raises capital over time, in each round it seeks to have a better valuation than in the previous round and usually new investors enter with every new transaction. When there is an appetite to invest in the startup, the round is oversubscribed, leaving some investors out of the transaction. At that time, current investors can offer their shares to those interested creating a secondary market by offering a price equal to or even higher than the last round. By doing this, current investors can get a partial or total exit from the investment. Similarly, there are platforms that create secondary markets such as Nasdaq Private Market and Sharespost where you can buy and sell equity stakes in companies that have not yet had an exit to the public markets. Investors sometimes seek a prior exit by trying to get their principal back even if this results in a small loss from a lower valuation.
- Resale of shares
In the VC world, investors can enter through preferred equity or Venture Debt. Sometimes Venture Debt investors may have a put option to resell the shares they own in the startup in order to liquidate their position. However, these provisions are not always present in Venture Debt contracts and often represent a problem for entrepreneurs if the fund exercises the option.
- Distribution of dividends
In the world of Private Equity (PE) it is common to do a leveraged recapitalization with the aim of issuing new debt which will be used to pay a special dividend to shareholders. This allows them to improve their financial return on investment. Although it is true that startups have an accelerated growth path and their leverage capacity is usually low since their cash flow generation is modest, there are certain occasions where some startups, such as SaaS companies, have the ability to generate significant cash flow and with this pay dividends to its investors.
According to statistics from Harvard, 95% of startups fail leading companies to a liquidation process in which investors are concerned about recovering at least a part of their investment. These processes are usually long and complicated and most of the times investors get little or nothing back on their investments. The investment recovery potential is determined by the priority that the investor occupies in the Cap table, as well as the relationship between payable assets and liabilities that the company has at the time of closing.
VC investments are typically long-term and low-liquidity investments. Investors have the primary objective of making an exit in order to have a financial return on their investment. Although the entrepreneur is working on the growth of the company in order to reach an acquisition or public placement in the stock market, investors should have their own vision and look for exit scenarios that best suit their interests. Having an open mind and understanding exit strategies in different ecosystems is vital to avoid wasting opportunities for return on capital. For example, WeWork investors probably expected to have a successful IPO and were left with the shares in hand without being able to recoup their capital. Those with a different perspective were able to have a secondary market exit with significant returns.
Hector Shibata. Director of Investments & Portfolio at ACV a global Corporate Venture Capital (CVC) fund and Adjunct Professor for Entrepreneurial Finance.
Ricardo Latournerie. VC Investor at ACV.
ACV is an international Corporate Venture Capital (CVC) fund investing globally in Startups & VC funds.
Stay updated about Venture Capital, innovation, entrepreneurship and more! Sign up for AC Venture’s monthly Newsletter.
Follow us on LinkedIn: ACV_VC
Follow us on Twitter: acv_vc
Follow us on Spotify: ACV_VC