Corporate Organisation of VC Firms in the US
Most mainstream firms or wealthy individual investors invest their capital through funds organized as limited partnerships.

Exiting a Venture Capital Investment
Exit routes consist of an IPO (initial public offering), trade sale of shareholdings, merger or acquisition.

The US Tax Regime for Venture Capital
The overall tax regime for venture capital investment in the US is reasonably benign.

Exiting a Venture Capital Investment

Exit strategies vary considerably according to the structure of investment, from the lone 'angel' investor at one extreme to publicly-quoted venture capital funds of funds at the other, but exit routes consist of an IPO (initial public offering), trade sale of shareholdings, merger or acquisition.

IPO

During the go-go years of the TMT boom in the 1990s, the initial public offering was the most popular and visible exit route for most venture capital investee companies. Investors, whether venture capital funds or individuals, are 'insiders' during a flotation and their shareholdings are subject to disposal limitations for after the IPO. Once the stock is freely tradable, usually after about two years, investors can choose whether to liquidate the investment and roll it over into another investment, or to hold the shares hoping for further appreciation. Funds or individuals making the latter choice in 1999 or 2000 had reason to regret their decision in many cases due to precipitate falls in high-tech company valuations, although conditions began to improve in 2002, and by 2004 some kind of normality had returned to the high-tech IPO sector. Over the last twenty-five years, almost 3,000 companies financed by venture funds have gone public in the US.

In 2009, the National Venture Capital Association (NVCA) unveiled recommendations addressing what it called a capital markets crisis for venture-backed companies in the US. Since the Internet bubble burst in 2000, the number of initial public offerings (IPOs) by venture-backed companies had declined alarmingly, culminating in the 2008 drought when only six companies entered the public markets. A healthy number of IPOs would be at least 150 a year, similar to the number of offerings in the 1990s, said the NVCA.

Mergers and Acquisitions

Mergers and acquisitions represent the most common type of successful exit for venture investments. In the case of a merger or acquisition, the venture firm or investor will receive stock or cash from the acquiring company. Less often than with an IPO, shares acquired in this way may be subject to 'lock-up' limitations for a period of time.

Valuations

It's a characteristic of the venture capital investment sector that investee companies will go through several rounds of financing as they grow towards the magic moment of an exit. Each round of financing requires that the existing and incoming investors should agree on a valuation of the investee company. During the glory days of the 1990s bull market, valuation was not difficult - just think of a number and double it!

Things have been very different since, not least because of the various types of 'umbrella' or 'claw-back' mechanism typically included in venture capital shareholders' agreements. There are various ways in which venture capital investors seek to limit the risks they are taking, and one of the more usual is to have a clause limiting the returns of other shareholders if exit takes place at a low valuation - thus the venture capital company may receive back its investment in cash before the sale proceeds are divided among the shareholders. It gets paid out twice, therefore. Such clauses are perceived as unfair by entrepreneurs when they operate at low valuations - but they are easy to skip over when you are desperate for funding!

The volatility of stock markets, the existence of lock-up agreements, and the protection clauses in shareholders' agreements taken together mean that valuing venture capital funds is much more of an art than a science. This doesn't matter so much in a closed-end fund with illiquid investments, where valuation may be irrelevant until the fund closes, but it matters a lot from a tax perspective to any investor whose investments are disposed of during the life of a fund or who is party to a takeover.

BACK TO TOP

Corporate Organisation of VC Firms in the US
Most mainstream firms or wealthy individual investors invest their capital through funds organized as limited partnerships.

Exiting a Venture Capital Investment
Exit routes consist of an IPO (initial public offering), trade sale of shareholdings, merger or acquisition.

The US Tax Regime for Venture Capital
The overall tax regime for venture capital investment in the US is reasonably benign.