VC Shenanigans, Chapter 1 (of Volume I, Book 1…)

December 3, 2015

vc_exits“Never a dull moment,” one on my favorite co-investors would like to quip. After practicing the business of venture capital for almost a decade and a half now, I’ve witnessed my share of moments that were anything but dull. Someday I’ll write a book, I used to think to myself.

Maybe someday. But until then, and upon popular request, I’ve decided to open a blog series on what I’m going to call VC Shenanigans. Now, I’m employing the term shenanigan as an attention-grabber, partly tongue-in-cheek (though only partly). I’ll openly share a broad collection of sneakiness, deceit, tomfoolery, and generally misleading behavior of VCs — not necessarily always with malicious intent — that I’ve observed (and in some cases, instigated myself) over the years.

Since I’ve spent the vast majority of my venture capital career in Europe, these shenanigans are confined to Europe, and in particular to France, Belgium and The Netherlands. Not that I’m suggesting that venture capital practices in Silicon Valley are entirely devoid of shenanigans; rather, I’m unqualified to speak about them.

I’ll begin with the end in mind: the VC Exit

The Exit is a fundamental tenet of venture capital. The underlying goal held by financial VCs in financing startup ventures is to generate a capital gain for their own investors (i.e. their LPs). Realizing any capital gains requires attaining an Exit for the investment. Anything short of an Exit represents an unrealized gain for the VC.

Europe’s venture capital sector has a shorter history than Silicon Valley’s, so it’s forgivable that certain best practices haven’t made it over across the pond. Moreover, Europe is not the U.S., so some American VC habits are less appropriate here.

Yet it disturbs me that a haze of confusion still exists around the basic venture capital concept of the Exit. Sometimes this is accidental, but on occasions the confusion is deliberate, as the stakes can be high for the actors involved.

So let’s set the record straight here and now with a simple definition. This explanation applies in the context of a venture capital investment, from the standpoint of the VC fund, and by extension for the investors in the VC fund.

An Exit for the VC is best defined as the realization of full liquidity for the venture investor’s stakeholding in the portfolio company, be it in the form of equity, debt, or anything in between. In other words, the Exit is the way the VC “cashes out” his/her investment.

  • The company is acquired for cash: that’s an Exit.
  • 100% of the VC’s stake is acquired for cash (even if the other stakeholders do not sell): that is an Exit.
  • The company buys back the VC’s stake for cash: that’s an Exit.
  • The company (or at least 100% of the given VC’s stake) is acquired for shares: the Exit is achieved once those shares are transformed into cash.
  • The company goes bankrupt and is liquidated: that is an Exit for the VC (albeit an unfortunate one).

An IPO is not an Exit

Notice that I haven’t cited an IPO as an example. An initial public offering (IPO) of a venture-backed company is not an Exit per se. True, an IPO can represent a significant step towards an Exit for the VC, but it’s a distinctly separate event.

When the venture-backed company raises money via an initial public offering, its shares subsequently become tradeable on a stock exchange. However, only when the VC fund is able to liquidate its stake (i.e. convert its shareholdings into cash), and not before, is the Exit achieved for the VC. While it is true that the VC fund may be able to sell off some of its stake to public investors as part of the IPO, only this limited portion, if any, can be considered an Exit for the VC, hence it’s a partial Exit at best.

I suspect that the reason the term Exit is often used as a shortcut for IPO is that the most well-known IPOs of VC-backed tech firms take place on the Nasdaq or the New York Stock Exchange. These exchanges are advanced stock markets with high trading volumes. A VC fund that owns shares in a Nasdaq- or NYSE- listed company can sell off its stake fairly expeditiously (after any applicable lock-up period of course), because the markets provide sufficient liquidity.

In Europe it’s a different story, especially in Continental Europe, where the main exchanges for tech IPOs are the Euronext, the Alternext, and some smaller regional exchanges. The VC’s selling off its shares as part of the IPO, while legally permitted, is nearly impossible without hamstringing the IPO prospects. Once public, trading volumes for the company are often low or non-existent on these exchanges (there are some rare exceptions). Absent substantial trading volumes, it’s extremely difficult for the VC fund to find buyers for its shares. Attaining liquidity and hence an Exit can easily take several more years after the IPO.

When it comes to tech VC in Europe, the term IPO is not synonymous with Exit. Far from it. Nonetheless, many VCs use the two terms interchangeably, and that’s a shenanigan.

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posted in venture capital by mark bivens

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