As the global economy sputters and pundits begin bringing up the term “double-dip recession,” VCs that best timed the market may generate the most impressive returns by making exits considered unorthodox for the asset class.
Private exchange SecondMarket recently reported that VC firms are among the majority of selling stakeholders now, often selling stakes to eager wealthy individual investors. There is no doubt auctioneers like SecondMarket and SharesPost have seen traffic pick up as Internet companies moved closer to eye-popping IPOs. Reportedly, Union Square Ventures has sold part of its stake in Twitter through private markets. Such a sale may have helped Union Square produce a gaudy IRR for its’ ’04 vintage fund, which UTIMCO reported was 73.4 percent.
Neither SecondMarket nor SharesPost publicize sellers, so it is difficult to determine which VCs are making the most exits pre-IPO. However, SecondMarket, in particular, has increasingly reached out to venture capital firms to solicit stake sales via their exchanges, something that industry professionals say many VC firms have responded to overtures positively.
VCs can make exits into secondary markets until right up before the IPO announcement (with the company’s blessing, of course), but once the selling stakeholders have been formalized, they will spend six months eyeing share price fluctuations if they need to recoup on their investment. Generally speaking, investors subject to share lockup agreements are held to them for 180 days (Pandora’s and Groupon’s are among them), says A.B. Mendez, senior analyst with secondary market research provider GreenCrest Capital Management. That leaves ample time for exposure to market volatility. But some VCs have found opportunities for other pre-IPO exits.
Big pre-IPO fundraisings allowed some VCs opportunities to cash out portions of investments early. For example, Rugger Ventures, New Enterprise Associates and Accel Partners took home more than $200 million from Groupon’s fundraisings.
But those bullish on the 2011 IPO crop point to evidence that suggests most VCs might want to hold onto their shares following a portfolio company’s going public. When LinkedIn went public, Goldman Sachs vacated its stake, selling all 871,840 shares in the IPO (a rare misstep), and Bain Capital Venture Integral Investors sold a portion of its holdings, as well. Sequoia Capital, Greylock Partners and Bessemer Venture Partners didn’t sell any of their shares in the offering, however and — as of right now — they look smarter for having done so. While they must have rejoiced in the professional network’s astounding first-day gains, the prospect of a softening NYSE must also unnerve them. LinkedIn’s going public translated into a massive value increase in each VC’s stake, but since the company’s meteoric debut the stock has slid roughly 20 percent from highs in excess of $100 per share.
There remains a chance VCs could get a reprieve from a market downturn via any of a number of sources. It is possible the Federal Reserve will plunge right back into another round of quantitative easing to buoy the U.S. economy, which will, in turn, give equities markets a shot in the arm. Even if QE2 ends with no new plan in place, market drops will likely one day be countered with the Facebook IPO, an offering widely anticipated to come in 2012. It is almost impossible to imagine Facebook shares would not rise following their debut, and it’s even more difficult to envision a scenario in which companies that share its business model would not benefit from the social network’s listing. Further, analysts seem to agree that even in the event of a double-dip recession, the follow-up downturn will not prove as painful as the recession that began in late 2007. If they prove themselves wrong, it will be 2011’s secondary market sellers that boast the best returns — if they are not already doing so.