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:
http://www.allenlatta.com/1/post/2012/08/ipo-101-ipo-lockup-periods.html
Link to my prior post on IPO lockups:
http://www.reuters.com/article/2012/08/15/venturecapital-ipos-consumer-internet-idUSL2E8JD9BV20120815
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:
http://www.allenlatta.com/1/post/2012/08/ipo-101-ipo-lockup-periods.html
Link to my prior post on IPO lockups:
http://www.reuters.com/article/2012/08/15/venturecapital-ipos-consumer-internet-idUSL2E8JD9BV20120815
