Fred Wilson, a managing partner at Union Square Ventures and author of the blog A VC, has a good post called "Lockups and Insider Selling" that is a good read. He begins the post by pointing out that the job of a venture capitalist to return capital to limited partners, and then says it again. He continues by discussing why VCs typically don't hold on to their stocks after a lockup expiration. Its a good post and worth a read. Here's the link: http://www.avc.com/a_vc/2012/08/lockups-and-insider-selling.html
SmartMoney is reporting that CalPERS, the nation's largest public pension fund and one of the world's largest investors, is threatening to boycott any stock that allows minority shareholders to control a majority of the votes through dual class or multi-class share structures. The article indicates that one in eight initial public offerings this year had multi-class structures, while this number was one in 12 in 2009.
The knock on multi-class share structures is that they render shareholders mute. By controlling the company, the minority shareholders (usually the founders sometimes combined with pre-IPO investors) elect the board and effectively make all major corporate decisions. From a corporate governance perspective, it's certainly not good for shareholders. On the other hand, it is precisely because these founders have been able to execute on a strategic vision that these companies are able to go public. In this sense, the multi-class structures lock in the founders and their vision for the company.
Recent IPOs that have dual or multi-class share structures include Facebook (two classes of common stock), Zynga (three), Groupon (two), Kayak (two), Yelp! (two), Zillow (two) and LinkedIn (two). Of these, LinkedIn, Zillow, Yelp, Kayak are trading above their IPO prices and Facebook, Zynga and Groupon are trading below their IPO prices.
In my view, whether a company can list with a multi-class share structure is really about demand for the IPO and the marketing of the IPO. If the IPO is in strong demand, then the underwriters may be able to structure an IPO that enables multi-tier structures, selling shareholders in the IPO, a larger number of shares sold, or a higher IPO price, or some combination of the above. The marketing of an IPO is both art and science, and the underwriters develop the structure of an IPO based upon market factors.
If CalPERS boycotts IPOs with multi-class structures that enable minority shareholders to control the company, AND if other large IPO investors join the boycott, then this might make it more difficult for IPOs to have these structures. Also, if the post-IPO performance of companies with multi-class share structures is poor, then IPO investors may shy away from these structures and they may fade away.
Link to SmartMoney article: http://www.smartmoney.com/news/on/?story=ON-20120820-000058
In today's Reuters article "Venture Capital feels the heat from ongoing dotcom turmoil" (which should be named "Venture Capital feels the heat from ongoing social media bubble bursting"), the impact on VCs of the major declines in the stock prices of companies including Facebook Groupon and Zynga are examined. More specifically, the post-IPO distribution strategies of the VCs and the impact on investors in the VC fund (the LPs) are discussed. It's an interesting article.
I have some additional thoughts on post-IPO distribution strategies used by venture capital funds.
Information advantage. VCs have much better information than their LPs about a portfolio company before it goes public. Even after the IPO, when the information advantage goes away (assuming the VC doesn't have a board seat), the VC has a better feel for the company, its management, operations and strategy. Add to this the incentive provided by carried interest (profit share) to maximize the value of the exit, VCs are in my view in a much better position than their LPs to determine when to exit a public stock position. It is for this reason that I typically don't question a VC's exit strategy.
Exit at IPO. The Reuters article implies that the VCs have the ability to sell at the IPO. This is true if the underwriters believe the offering can be successful with shareholders selling in the IPO. In the old days when I was an investment banker, most technology IPOs did not have selling shareholders - all of the shares were offered by the company. While it is more common today to see selling shareholders in a tech IPO, whether shareholders can sell at the IPO is a decision made by the underwriters and the company. Having said that, some VCs will show support for the company by not selling in the IPO, which shows the IPO market that they have confidence in the company and helps the IPO to sell. In a rare case, VCs may actually buy shares as part of the IPO to show support for the company (and to make money of course). Other VCs want to realize some profits at the IPO and will sell a portion of their stakes in the IPO if they are able.
Post-IPO exits. When a company goes public, its officers, directors and most pre-IPO shareholders agree to not sell their shares for 180 days (sometimes less) after the IPO. This is known as the "lockup period" and is discussed in my prior post here. VCs are subject to this lockup, and once it expires, there are different strategies that are employed by the VCs to exit their position. The post IPO exit strategy will depend on a number of factors: (a) the number of shares held by the fund and the size of this position relative to share float and trading volumes; (b) the VC's assessment of the future prospects of the company and its stock price; and (c) insider status (if the VC is a director or officer of the company or owns 10% or more of the company's stock).
Once a lockup expires, some VCs will distribute shares to their LPs in a stock (or in-kind) distribution. The size and timing of the distribution will depend on the factors above. Other VCs may slowly distribute shares in tranches over a long period of time ot minimize the impact on the market. Some VCs will sell the shares and make a cash distribution to their LPs. Yet others may hang on to the shares for a longer time as they believe the stock price will appreciate in the long run.
If a VC is an insider, then the exit process is more complicated. In general, I prefer that VCs resign from the board of a company before the IPO. In my opinion, at that point the VC has fulfilled its role of shepherding the company from initial investment to its IPO, and at the IPO the VC should resign. Some VCs will stay on boards of companies after they go public with the rationale that it provides benefits to other portfolio companies. I understand the logic, but would prefer that they resign from public boards to reduce their board seats and spend more time with other private portfolio companies. Also, being a board member of a company as it goes public has certain legal risks - if the IPO doesn't perform well, there will certainly be shareholder lawsuits that will be a drain on the directors time.
Link to the Reuters article:
Link to my prior post on IPO lockups:
When a company holds its initial public offering, the prospectus will contain a provision that says that all of the company's officers, directors, employees and substantially all of the company's stockholders have agreed with the company and the underwriters not to sell shares for a specified period of time, usually 180 days, but sometimes less. This period of time is known as the lockup period, and the purpose of the lockup period is to limit the number of shares of the company's stock that is available for sale after the company goes public. The concern is that if a large number of shares is put up for sale soon after an IPO that the market for the company's stock will be roiled and the stock price will drop.
To find lockup information in the IPO prospectus (known as a 424B4 SEC filing), look in the "Shares Eligible For Future Sale" section and the sub-heading "Lockup Arrangements" or "Lock-Up Arrangements." Here's a link to Zynga's prospectus and the "Shares Eligible For Future Sale" section, where Zynga had a 165 day lockup period. Facebook has a staggered lockup period, with one period expiring 91 days after the IPO, another at 181 days and a final period expiring after 211 days.
Stock Price Drop on Lockup Expiration. Even though the market has advance notice that a lockup period is expiring and so the event should be priced into the market, it is still a common occurrence that a the stock price will fall when a lockup period expires. As an example, when Groupon's lockup period expired on June 1, 2012, the stock fell almost nine percent, on trading volume that was nearly four times greater than the prior day. Note that Groupon had a very large overhang of stock (up to 603 million shares) that was eligible for trading when the lockup expired, when the IPO was for 35 million shares, so a 17x overhang. Note also that Groupon's original 180 day lockup period was extended when the company restated earnings at the end of March.
Secondary Offerings. One way companies and underwriters manage this process is to undertake a secondary offering prior to the lockup expiration. This typically only occurs if the stock has been trading up in the aftermarket. The benefit of a secondary offering is that the offering is marketed by the company and the underwriters, and it is an orderly process with usually minimal impact on the share price. It also reduces the number of shares that will flood the market when the lockup period expires. Typically in secondary offerings the shares are being sold by insiders and pre-IPO investors (such as venture capital and private equity firms) and not by the company.
As an example, Zynga held a secondary offering in March 2012 in which all of the shares sold were from selling stockholders. Zynga's IPO priced at $10 per share in December 2011 and the secondary offering priced at $12 per share in March 2012. There were 100 million shares issued in Zynga's IPO and almost 43 million issued in the secondary offering, for a secondary offering size of less than half that of the IPO. This secondary offering helped to reduce the number of shares that would be available for trading when the lockup restriction expires.
Robert Moore, the co-founder and CEO of RJMetrics, a business intelligence software company, has an interesting post on the RJMetrics blog called "The Clubby World of Venture Capital." The posting explores the "clubbiness" of venture capital by analyzing the firms that tend to invest in the same companies together. Moore has even developed a "clubbiness ratio" to identify the firms that tend to invest with a small group of co-investors. Some conclusions from the analysis:
The recent New York Times article "How Big Data Became So Big" explores the meaning behind the term "Big Data" and its evolution. It's a good article to help one understand how the term Big Data came into being and what the term means. Here's the link: http://www.nytimes.com/2012/08/12/business/how-big-data-became-so-big-unboxed.html?
CalPERS, the largest US public pension fund with $233 billion in assets, is considering trimming its exposure to venture capital, according to reports. The reasons given were that venture capital has been the worst performing asset class over the past 10 years and that CalPERS' huge size makes it difficult to obtain access to the best venture funds in an amount that will make a difference to its performance.
I have two thoughts on this:
Links to articles:
The article on Forbes.com "Private Equity In China: Too Much Money, Too Few Deals" explores some of the issues confronting the Chinese private equity industry. The article points out how "official" statistics may understate the actual situation, as unofficial estimates indicated that at the end of 2011 there were more than 10,000 venture capital and private equity firms in China, while official estimates were for 882 such firms. As the title implies, the article argues that there is too much money in China and a shortage of good deals. The article points out other issues, including:
The article is an interesting read. Here's the link:
500 Startups, the seed fund and startup incubator program based in Mountain View, CA, has expanded into Mexico by bringing Mexican startup accelerator Mexican.VC into the 500 Startups family. According to the blog post by 500 Startups on the merger, the goal is to help fund and launch more startup companies in Latin America. According to the post, Mexico is the 12th largest economy in the world, and with 3.9% growth, it's growing faster than Brazil. In addition, Mexico has the fifth largest Facebook user base and the seventh largest Twitter user base in the world. Further, e-commerce is growing roughly 30% each year in Latin America.
Link to 500 Startups post: http://500.co/2012/08/07/500-startups-mexican-vc-hostile-takeover/
Links to articles:
A recent posting on the WSJ blog Venture Capital Dispatch, "Sequoia Capital Seeks Bigger Role in India's Maturing Venture Industry" highlights Sequoia's venture capital strategy in India. According to the post, Sequoia Capital India is investing out of its third fund of $725 million, and will look to raise a fourth fund in the second half of next year. The posting also indicates that Sequoia targets a 3-5x return in a 3-5 year time frame.
The posting also suggests some challenges for venture capital in India: a slowing economy and a difficult IPO market. In previous posts, a number of other challenges for investing in India have been identified, including:
Here's a link to the posting:
Here's a link to my prior post on challenges of investing in India:
John Backus, a co-founder and Managing Partner of New Atlantic Ventures, was profiled recently by the Washington Post in the article "Value Added: A venture capitalist learned to invest in entrepreneurs by becoming one first." The profile discusses John's operating background, the lessons he's learned from being an entrepreneur, and how he approaches new deals today. It's an interesting profile. Here's the link: http://www.washingtonpost.com/business/economy/value-added-a-venture-capitalist-learned-to-invest-in-entrepreneurs-by-becoming-one-first/2012/03/25/gJQAktKVZX_story.html
Reuters is reporting that LegalZoom.com, the online legal services company, has delayed its initial public offering due to market conditions. on August 1, LegalZoom had filed an amended registration statement with the SEC indicating that it planned to sell 8 million shares in the IPO (3.8M from the company and 4.2M from selling shareholders) at a price range of $10.00 to $12.00 per share.
Morgan Stanley is the "left lead" underwriter, and is joined by BofA Merrill Lynch as joint book-running manager. Stifel Nicolaus, William Blair, RBC and Montgomery & Co. are co-managers of the offering. Venture Capital investors listed in the S-1 include Polaris Venture Partners, Institutional Venture Partners and Kleiner Perkins Caufield & Byers. Polaris was planning to sell 3.5M shares in the IPO (plus another .5M in the over-allotment option), while IVP and KPCB were not planning to sell any shares in the IPO (or in the over-allotment option).
Here's a link to the Reuters story:
Here's a link to the latest S-1/A registration statement: http://www.sec.gov/Archives/edgar/data/1286139/000104746912007609/a2209713zs-1a.htm
Here's a link to my prior post on LegalZoom:
The Jumpstart Our Business Startups (JOBS) act was passed earlier this year, with the intent of making it easier for "emerging growth companies" to raise money in an initial public offering and through private placements. The peHUB article "The Unexpected Outcomes of the JOBS Act" provides some insight as to the unexpected consequences of the Act. The article identifies the following:
Link to the article: http://www.pehub.com/161586/the-unexpected-outcomes-of-the-jobs-act/
Some buyout firms are having a difficult time selling businesses as buyers are waiting for prices to fall, according to an article by Reuters. The article "DealTalk - Buyers' stand-off threatens to choke private equity" indicates that part of the problem is that buyout firms are unwilling to sell companies at current prices as it could mean they could miss out on the carried interest (profit share) for the fund. Moreover, the article suggests that some buyout funds may disappear as a result of poor performance. It's an interesting article. Here's the link: http://www.reuters.com/article/2012/07/18/privateequity-deals-standoff-idUSL6E8I9B4X20120718
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