19 - The Divestment Process

Abstract

Part V comprises Chapters 19–22 and considers the divestment of venture capital and private equity investments. The term divestment in this case refers to the sale of venture capital fund investments, otherwise known as “exits.” This chapter provides an overview of the issues to consider during the divestment or exit process. Exits are central to the entire venture capital and private equity investing process. Investee entrepreneurial firms typically lack cash flows to pay interest on debt and dividends on equity. Venture capital funds therefore really only profit from capital gains upon exit from investee entrepreneurial firms approximately 2–7 years from initial investment. There are five ways in which a venture capital or private equity fund may exit an investment: (i) Initial Public Offering (IPO): a new listing on a stock exchange. (ii) Acquisition (merger): a sale to a firm larger than the one being acquired. Both the entrepreneur and the venture capital fund sell their stake in the firm in the case of an acquisition exit. (iii) Secondary Sale: a sale to another firm or another investor. The venture capital fund sells its interest but the entrepreneur does not sell his interest. (iv) Buyback: the entrepreneur repurchases the stake held by the venture capital fund. (v) Write-off: a liquidation of the investment. In this brief overview chapter, we review the economics of initial public offering markets, discuss a general theory of exits and why we observe different exit outcomes and full versus partial exits, and describe the performance of venture capital-backed IPO and acquisition exits. As well, in this chapter we provide an overview of issues to be considered in more detail in Chapters 20–22.