A divorce made in heaven

Aligning shareholder expectations with your funding source’s plans need not cause any problems, if you plan the process now. DORON BEN-MEIR

By Doron Ben-Meir

In a previous blog entry, I likened a VC investment to a marriage. The analogy has an interesting twist. Even before the VC marriage is consummated, there is open planning between the VC and founders about how to divorce (not if but when…). Some might say that this would be good practice for every marriage… no comment!

The expectation in the VC context is that the divorce will be a very pleasant experience precipitated by the successful sale of the business – typically via trade sale (M&A) or IPO.

No problem you say… we all want to make a fortune when we sell the business.

No doubt… but the question is whether the interests of the VC and ordinary shareholders remain aligned throughout the process. VCs operate within timing constraints, which can profoundly impact such alignment.

Venture capital investors – particularly those managing third party funds – are constrained by a timing window within which cash invested must be returned to investors together with any profits made.

Most venture funds have a designated lifetime of 10 years and an investment period defined as the first five years. After the investment period, the VC manager typically will not invest in any new businesses but will execute follow-on rounds in existing portfolio assets.

Therefore, on average, a portfolio asset will be held for between three and seven years before the VC manager requires a liquidity event – a transaction which converts the shareholding into cash or stock in a more liquid entity, for example a listed company with reasonable trading depth.

If the business is not ready to be sold when the VC is faced with a liquidity imperative, the business may be distracted by the VC attempting to find a buyer for its shares (such as secondaries fund, other VC, corporate acquisition etc). In some cases (subject to shareholder agreement provisions) the VC may have a unilateral right to require the company to be sold. This could result in a reduction of ordinary shareholder value.

Founders and entrepreneurs need to carefully evaluate their circumstances and business plans and be comfortable that they will either succeed in that time frame or be prepared to work with their VC to help them exit the business – potentially at the expense of some enterprise value. One might view this risk as a trade-off against the positive impact of the cash injection and, hopefully, the value addition brought by the VC manager.

VCs will do all they can to qualify the suitability of your business for the venture capital process, but as we all learn from bitter experience… it always takes longer and costs more money than you think – so be prepared.

Doron Ben-Meir has been an active venture capital manager for the last eight years. He founded Prescient Venture Capital and prior to that was a consulting investment director of Momentum Funds Management. He was a serial entrepreneur over a 12 year period, co-founding five new technology based businesses.

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