Venture capital funds want to write better emails

Optics are probably worth the price

Cute venture capital investments.

One of the pressures of early stage venture capital investing is that exiting an investment is tough. You start by being a champion of the startups you just invested in. You might write blogs about them, name-drop them in podcasts, tweet about them, that sort of stuff. But a few years down the niceties are gone, you know your winners and losers. You need a return on your investment and want to move on.

There are three ways this can happen:

1. A larger company acquires the startup.

2. The startup does an IPO and goes public.

3. You sell your stake in the startup to another fund.

These aren’t equal outcomes. An IPO is almost always nice for you. An acquisition may or may not be, depending on the situation.¹ Selling your stake to another fund? That seems to be on the edge.

Last month, Moneycontrol published a neat piece about this on-the-edge scenario:

An increasing number of fund managers are now moving away from investing primary capital via venture capital funds and are setting up their own secondaries fund as they look to build more exit options that go beyond initial public offerings (IPOs) and mergers and acquisitions (M&As).

A secondaries fund is one that buys shares in a firm from an existing backer. The transaction is between one investor and another, nothing goes into the company’s cash chest, unlike a primary fund raise. During secondary deals, private company shares are also available at a discount, sometimes as high as 40 percent, giving an entry option to those who may have missed out earlier.

VC fund managers, who were identifying and investing in startups, are now solving a problem for other VC fund managers who need money and want to exit some of their investments. They’re setting up funds to buy out VC funds’ stakes in their companies.

But there are nuances! Any VC fund would have some winners and some duds. The winners usually win big, and the duds are essentially worthless. The fund wants to sell its duds and keep its winners. The buyer, of course, wants to buy the winners and not the duds. How does the trade even happen?

A discount is one part of it. A VC fund typically invests for a decade, and if the 10-year mark is closing in, the fund’s own investors may be breathing down the fund manager’s neck to see their money back. So a desperation discount on the company’s last valuation seems reasonable. But hey, no one wants to buy a discounted stake in a worthless company either.

Here’s the solution:

For instance, Chiratae Venture Partners recently sold some shares of its portfolio companies bundled with shares of Lenskart – one of its hottest properties – which made the entire block more attractive and was easier to find buyers, one of the persons privy to the developments told Moneycontrol.

“The general partner, who's giving you a prized asset, which he can very well sell to others in the market, will also want to offload a little bit of his lemon assets. However, the secondary fund buying will want to buy just the prized assets. So, it all boils down to the buyer and how much command they have over the deal,” a third person, who runs a secondary fund, said.

A VC fund that wants to sell its bad assets must pick one of its good assets, package them together, and sell the bundle. Sounds a lot like cable television.

I wonder what this does to the price of the bundle. In the example from Moneycontrol, if you’re Chiratae Ventures and you’re selling your stake in Timbuktu, Inc (which no one wants) along with your stake in Lenskart (which everyone wants)—does the buyer pay more or less than they would have just for your stake in Lenskart?

I’d think the price of the bundle would be less than the price of just Lenskart. Timbuktu, Inc is mostly a lost cause. But investing in a startup is still work for the buyer. They need to speak with the founders, pay lawyers, sign paperwork, pretend to be happy, etc. All of this is negative value and the buyer is doing the seller a favour. For a price, of course.

It seems like a great deal for the buyer. They get a company that’s a winner and likely to IPO soon. They get a desperation discount on its last valuation, plus an overall bundle discount.

By the nature of early stage investing, most companies a VC fund invests in are going to be duds. But still, if you’re a fund manager sending out a quarterly report, you’d prefer saying, “Good news! We exited 10 very healthy, very successful startups. Here’s your money back”, as opposed to, “Umm, we exited the only company that we all knew would be going public anyway. Here’s your money back, but hey don’t you ask about the 10 other companies that are clearly sitting ducks”.

VC funds are okay getting less money for their bundle if they can write emails that sound better.

Cover Photo by Petr Ganaj/Pexels

1. Walmart buying Flipkart was a great exit. Flipkart buying Jabong, not so much. If the price the buyer is paying is more than the company’s last valuation, it’s great. Otherwise it’s not.