Venture capital exits – trade sale vs IPO – compared and analyzed

Andy Lau has substantial experience representing pe/vc funds, investment banks and startup and growth companies in pe/vc investments, M&A, IPO and capital markets transactions. For a preliminary consultation, please email him at andy@askventure.com.

Way before a venture capitalist invests in a company, he is already thinking how and when to exit from the investment. This article tells you why and compares between the two venture capital exits – trade sale and IPO.

Illiquid nature and limited life-span of a VC fund

A well-planned exit is particularly important in a VC investment because of two reasons:

1. Unlike investing in the capital markets or shares in publicly traded companies, profits or capital gains (if any) from investment in startup companies often take a few years to realise. A viable exit from a VC investment often is not possible until a few years after the investment.

2. A VC fund often has a limtied life-time and any profits or capital gains need to be realised before its expiry. This can be so even if the value of the investment may have potential for further growth beyond the period of the VC fund’s life-time.

Trade sale as a venture capital exit

The most significant benefit of a trade sale exit is that it is a complete and immediate exit, as opposed to IPO exit (see below). Trade sale allows VC to sell all or part of their shares in a company to a purchaser. It also gives control on the VC to negotiate with the purchaser on the terms of the trade sale.

VC will often not provide indemnities to the purchaser. This ensures a “clean exit”.

IPO as a venture capital exit

IPO is not an immediate exit. An IPO (initial public offering) means that part of the shares in a company is floated on a stock exchange and are tradable freely on the stock exchange.

VC can only truly exit when they sell their shares in the listed company. VC will not be able to sell their shares immediately after the company is listed because (A) they will be subject to a lock-up undertaking pursuant to their agreement with the underwriter and (B) some stock exchanges impose a lock-up period on the pre-IPO shareholders of the company when it becomes listed.

Exit related clauses in a venture capital term sheet

Because of the various restrictions and hurdles relating to venture capital exit, you will find that a typical venture capital term sheet contains terms that facilitate a VC exit or protect a VC’s rights in relation to other shareholders’ exit. For example, tag along rights, drag along rights, right of first refusal (ROFR), etc. I discuss these rights in separate posts.

Related posts:

1. Risky but High Potential Return Nature of Venture Capital Investments
2. What are demand and piggyback registration rights in a venture capital investment?
3. How to Calculate Liquidation Preference of Preferred Stock in a Venture Capital Financing?
4. What is Series A Convertible Preferred Stock Funding and Financing in a Venture Capital Investment?
5. From Seed Capital to Angel Investors to Venture Capital Funding – Startup Company Financing Model

Related resources:

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