Best Practices for VCs in the Secondary Markets

One of the primary drivers of the National Venture Capital Association’s policy successes over the years has been our ability to tell positive stories about venture capital’s track record of funding innovation, empowering entrepreneurs and transforming how we live.

Largely, this focus has been enabled by a relative lack of counter narratives concerning conflicts of interest, fraud and other headline-grabbing malfeasance. Venture capitalists today enjoy a well-earned reputation on Capitol Hill as responsible market participants.

That’s why we view the recent rise of activity in the secondary market for securities of venture-backed companies as another opportunity for VCs to demonstrate their leadership. For this purpose, NVCA has worked closely with Mary Kuusisto of Proskauer Rose, our outside general counsel, to provide our members with recommendations for navigating the growing secondary markets and managing exposure to the new risks that these markets may pose.

Develop Policies on Individual Trading Practices

The NVCA understands that the decision of a venture firm to invest in portfolio companies is determined within the discretion of the fund’s general partner. That said, we formally recommend that every venture capital firm develop a policy, tailored to its organization, regarding investment activity by its partners and employees. This policy discussion should include the obligations of GPs and the firms, as well as the delineation of any approvals that may be required by limited partners.

Depending on the nature of each particular firm, policy options that may be appropriate include the following:

• Notification to the firm of a partner’s or employee’s individual investment activity.

• Prohibition by the firm of individual investment in particular areas (such as particular geography, sector, stage).

• Pre-approval by the firm of any individual investments and/or waivable prohibitions of particular types of individual investments.

• Non-waivable prohibition of individual investments.

Individual trading policies that meet the needs of the firm’s GPs, LPs and portfolio companies, venture capital firms demonstrate their status as responsible market participants.

Know the Implications of Selling Shares on the Secondary Market

While the secondary market can provide liquidity to shareholders, it also involves issues that must be managed to avoid significant liabilities. These issues include:

• Securities laws associated with private company stock sales, including insider trading

• Unplanned and unwanted changes in the shareholder base

• Complications for IPOs or sale of the company

• 500 shareholder threshold for becoming a public company

In late April, the NVCA held a public webinar, led by Frank Currie, a partner at David Polk & Wardwell, to facilitate discussion and offer recommendations on strategies that venture firms and portfolio companies can employ to mitigate these risks. A replay of the discussion and the presentation slides are available to the public on the NVCA website (www.nvca.org). Awareness of these issues is critical to any venture-backed company that is considering selling shares on the secondary market.

Maintain Focus on the Public Market for Venture Backed Companies

While the secondary markets have generated significant buzz, we should remember that their rise has been fueled by the moribund U.S. IPO market. What our country and the VC ecosystem still need are more American companies going public.

The NVCA continues to focus advocacy efforts on this issue. We believe that there are many ways in which the government can help make the path to IPO smoother for smaller emerging growth companies. A robust venture-backed IPO market provides a number of very important benefits that cannot be replicated in the private markets today – including significant job growth.

In the interim, the NVCA will continue to monitor the activity and regulatory dynamics of secondary trading platforms in the coming year so that we can properly advise our members on issues associated with participating in these emerging marketplaces.

Mark Heesen is president of the NVCA. He can be reached at mheesen@nvca.org.