Introduction to Corporate Finance

ONLINE CHAPTERS

20-3f EXIT STRATEGIES EMPLOYED BY VENTURE CAPITALISTS

AND PRIVATE EQUITY MANAGERS

VCs are not long-term investors (although non-VC PE investors can be longer-term investors than pure

VC investors). They seek to add value to a private company and then to harvest their investment. VCs

use four principal methods to exit an investment: (1) through an initial public offering (IPO) of shares to

outside investors; (2) through a sale of the company they hold directly to another company in a trade sale;

(3) through selling the company they hold back to the entrepreneur or founders, known as the redemption

option; or (4) by selling their stake to another PE investor or fund – known as a secondary investment. IPOs

are by far the most profitable (and glorious) exit option for venture capitalists, though trade sales are also

quite profitable on average.

During 1980–2004, 3,374 venture capital-backed IPOs were executed on US capital markets and

raised $155.1 billion. In the midst of the global financial crisis and recession, in 2008–09, IPO activity

declined steeply. Only 21 VC-backed IPOs took place in 2008–09, though a slight rebound occurred in

2010, with 39 VC-backed companies going public.

As can be seen from Table 20.5, in financial year 2015, the largest number of Australian exits (or

divestments) were via trade sales and these accounted for around 28% of the value of total divestments.

For the year, the total number of IPOs was only 8. However, these IPOs raised around $1.4 billion (43%)

of the total $3.2 billion capital raised from VC and PE exits for the year.

Perhaps surprisingly, VCs do not exit immediately at the time of an IPO. Instead, they retain shares for

several months or even years before either distributing them to the limited partners or selling the shares

on the open market and then distributing the cash proceeds to those partners. The distributions usually

occur after a period of sharply rising share prices, and the average share price response to distribution

announcements is significantly negative. In some markets, VCs are embargoed from exiting their entire

LO 20.3

redemption option
Option for venture capitalists
to sell a company back to its
entrepreneur or founders

secondary investment
A stake in a PE or VC fund
purchased from an existing
investor. Since this is the only
means of liquidating a PE or
VC investment before the end
of the fund’s term, an initial
limited partner will probably
have to sell its stake for a
significant discount to its true
value

TABLE 20.5 DIVESTMENTS BY AUSTRALIAN VC AND PE FUNDS IN FINANCIAL YEAR 2014 (BY EXIT ROUTE)

Venture capital Private equity Total

Type of divestment Divestment at

cost (AUDm)

No. of

companies

Divestment at

cost (AUDm)

No. of

companies

Divestment at

cost (AUDm)

No. of

companies

Divestment by trade sale 69.73 10 825.51 10 897.02 20

Divestment on flotation

(IPO)

N/A N/A 1,379.38 8 1,379.38 8

Sale of equity post-flotation N/A N/A 708.61 10 708.61 10

Secondary sale N/A N/A 157.59 7 157.59 7

Other 26.77 4 35.03 3 61.80 7

Total divestments 96.49 14 3,106.12 37 3,202.61 51

Notes: Divestment types with fewer than three companies have been aggregated into ‘Other’.

A given company can be divested by multiple methods by both a venture capital and a private equity fund.

Source: Australian Private Equity and Venture Capital Association Limited. Used with permission. 2015 Yearbook Australian Private Equity and Venture Capital Activity Report,

November 2015. AVCAL in partnership with Ernst & Young, p. 21.