Everyone needs an exit strategy. Whether you are the founder of a business, an investor or someone at a party who wants to go home.
Having a major liquidity event as an entrepreneur typically happens in one of two ways. Either someone buys your company or you list it on a stock exchange.
Someone once said, “companies are bought, not sold”. Meaning the best outcomes for a founder and her investors typically appear when they aren’t looking for a sale. The company is tracking well, maturing, and heading in the right direction. Up and to the right as they say.
This is often when a potential buyer comes knocking. They’ve seen you execute well and grow in the marketplace. They believe that your business would be a good edition to their capabilities and they want you onboard. If the offer is attractive to the founders and the main shareholders, everyone wins. This is what most startup entrepreneurs are driving towards and where most liquidity events occur within the venture backed startup world.
Whilst most founders dream of ringing the bell as their company IPOs, more often than not this will not happen.
But, there is a third option.
Secondary sales of private company shares is one way of creating liquidity in a highly illiquid market for company founders, investors, and employees. Secondary sales have been growing in popularity over the past 5 years or so.
Traditionally, option one and two were your only chance of exiting a position in a company, and with companies globally, choosing to stay private for longer, secondaries are a welcome addition for all stakeholders.
Now in the world of startup investing, we spend a lot of time thinking about where to invest, how much and at what price. In short, the focus is very much on making the right investment in the first place.
This is of course good and right. But a topic that is all too rarely discussed is when to think about selling a portion or all of your position in a company.
This of course depends at what stage you are investing, but if we focus on seed stage investing as an example, the general consensus amongst VCs has been to hold onto your winners until the bitter end, ie until an IPO or company sale. These days, this can easily be more than 10 years from the original investment.
At Nascent we believe, if you run a venture fund strategy below $50m, you should seriously be thinking about taking some money off the table as a portfolio company approaches the $200m valuation mark. If you are investing early, at around the $10m pre money valuation mark as a seed investor, and writing meaningful cheques, these types of MOIC multiples achieved via a secondary sale to a later stage investor, will send you well on your way to returning your fund.
The quest for DPI (Distribution to paid-in Capital)
Distributed returns is the phrase on the lips of many LPs these days.
With many funds having solid paper returns but limited actual returns, fund investors are starting to ask the question, “if you haven’t returned capital over the last 5+ year venture bull market, when will you?” - it is an increasingly difficult question to answer as a fund manager.
One market reality that feeds into why many venture funds haven’t made distributions to their LPs in recent years is because, due to the exponential increase in fund sizes by many managers over the last few fund vintages, the exit valuation outcomes required to return a venture fund by 3x (the typical benchmark) need to be a LOT bigger than they used to be. Many VCs with funds of $100m or more, need multiple billion dollar company exits to simply hit their benchmark.
To us at Nascent this makes very little sense. That’s needle in a haystack stuff. Which is why we believe seed stage strategies should be kept modest in order to be able to optimise for top quartile distributed returns.
We believe having a clear exit strategy that includes a strong view on how you think about secondary share sale opportunities within your portfolio is fundamental, if you are going to be successful in returning meaningful capital to your investors within the 10 year fund lifecycle.
At Nascent, we were able to provide a 4.6x DPI multiple on our Fund I precisely because we had a clear secondaries strategy in place. This forms the basis of our thinking for Fund II.
Until next time.
Saludos,
Archie, Bernardo and Victor
If you are interested in learning more about what we are building at Nascent, we would love to connect!
Archie@nascent.vc
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