Succeeding in Venture Capital is Mostly About Knowing What to Buy. But When To Sell Matters Also.

Primary Thoughts Well-nigh Secondary Transactions

As my man Kenny Rogers sang…

You’ve got to know when to hold ‘em
Know when to fold ‘em
Know when to walk away
And know when to run
You never count your money
When you’re sittin’ at the table
There’ll be time unbearable for countin’
When the dealin’s done

Starting a venture wanted blog post with 1970s country music lyrics is pretty uncommon, but so is writing well-nigh when and why an investor might segregate to sell probity surpassing the visitor exits. Unelevated I’ll share some of the principles we use at Homebrew, knowing that there’s not really a single ‘right’ wordplay for a fund manager. Most of this discussion is well-nigh ‘playing offense’ — working towards stuff a good steward of LP wanted and the risk/reward associated with VC. I’m not going to imbricate reasons to sell that I’d consider ‘playing defense’ — mostly exogenous factors which involve LP pressure for liquidity on non-optimal timelines, dissolution of funds due to partnership issues, and so on. These are all rare, but real, and fortunately not anything we’ve dealt with in our firm.

So for the most part a venture investor holds their probity until the visitor exits via an acquisition, IPO, or some sort of other liquidity event (management buyout, whatever). But expressly over the last decade, the opportunities to sell superiority of an outcome for the visitor multiplied dramatically. As increasingly growth and crossover investors came into the startup ecosystem they were often eager to put wanted to work and happy to consolidate their positions with worldwide or preferred shares from early employees, founders and previous investors. The surplus of wanted moreover meant that new funding rounds often presented opportunity to sell portions of probity to current investors who otherwise were seeing their pro rata allocations cut back. And finally, a increasingly robust (but still somewhat opaque) secondary market emerged for transacting probity among parties.

As an early stage fund, often ownership 10–15% of a visitor during its seed financing, this meant we were often stuff asked if we wanted to sell portions of our stakes to other tried investors (let vacated the random pings from market-makers unaffiliated with the company). As former product managers Satya and I lean towards having frameworks for these sorts of decisions, for both consistency and speed in internal operations. We started by asking our LPs (a relatively small number of institutional investors) and other experienced VCs what they’ve seen play out and how, if applicable, they decide what to do with their own holdings. Then we combined this with observed data from the policies by coinvestors in our own portfolio.

Not surprisingly there was no specific consensus. There were examples of unconfined investors who said “never sell early — you ride your winners as long as you can” and others who had *very* specific formulas for when they sell (when it hits X valuation, take Y percent off the table each subsequent round; unchangingly sell until you hit a unrepealable return multiple for the fund, then hold after; and so on). This was helpful considering it let us know that (a) there wasn’t a universal weightier practice and (b) peers could have the same goals but take variegated paths to get there. And so next we codified our own ruleset. It sounds basically like this:

• Every time a portfolio raises a new round we should be ‘buyers’ or ‘sellers’ — that’s not to say that we buy or sell into every round, but objectively we should want to be on one side of the table or the other. We should have an opinion, although one that’s informed by our own fund strategy. That is, we should be buyers or sellers as a well-matured early stage fund, not trying to say “well, if we were a growth fund what would be do.”
• We should strive to execute decisions that are both in the weightier interest of the visitor -AND- in the weightier interest of Homebrew. I’ll caveat this unelevated but we want to be protective of the longterm interests of the company, the CEO, and the coinvestors. You don’t try to reprice the visitor on your own. You don’t bring investors on to the cap table via a secondary transaction that are going to be problematic. And so on.
• Pigs get fat but hogs get slaughtered. Plane if we believe a visitor has tremendous longterm upside, it’s not inappropriate to take some money off the table in order to manage that risk. As we’re recently reminded, markets go down, not just up. Just be enlightened of the incentives, emotions, and other factors at play. It’s ok to behave one way surpassing you hit your DPI target and flipside way after, but understand how those factors produce largest or worse possible outcomes. This is moreover true with regards to recycling. If we can sell partially out of a position and put those proceeds into one that we believe has increasingly incremental upside, that’s accretive to our results.
• We’re aligned with the founders and the rest of the cap table until we aren’t. All the preferred stock is pari passu and behaving honorably in the weightier interest of the company? Great. The founders are taking some money off the table in secondary but still very much locked in on towers and making funding decisions that are resulting with that? Great. In these cases there’s very little spare complication. But if this breaks, we need to reconsider how we think of our own positions. Not in darkness, but expressing concerns first and then doing the weightier version of what we can to treat the visitor fairly but moreover do our fiduciary interests for our LPs. What’s an example of a situation that might start fracturing the cap table? Imagine the CEO is sitting with two funding offers. One is a wipe termsheet, no structure. The other has a ton of structure (preferences for the new investor) but moreover offers an probity refresh to the exec team, or has a handshake with the CEO that they’ll buy $30 million of probity from them without close. You might think, “Hunter! This doesn’t happen — a Board would stop it” (or whatever). And I’d say, it does plane if it sucks for other investors and the employee worldwide shareholders. Again rarely but if you do venture long unbearable you see at least one of everything. At moments like this, if they occur (and I can say we haven’t experienced anything this grievous to the weightier of my knowledge), all of a sudden we’re not rowing in the same direction.

Much of success in venture is knowing what (and when) to buy. If you do that well it’s very difficult to mess it up. Conversely, if you’re not a good picker, it’s difficult to overcome that, plane if you had perfect timing on secondary sales. But sometimes the difference between B and A- (or between A and A ) can be a well-timed visualization to turn unrealized gains into partially realized.