Buying a portfolio of direct venture investments is not easy. There are many places where deals can unravel. Here is how these deals are done.
Buyers of “director venture portfolios” are proactive and regularly approach venture groups with the prospect of selling. They also get referrals from current portfolio companies, general partners they have worked with in the past and other venture investors. Placement agents and advisors hired by sellers are useful also. If a portfolio of assets is going to be sold off in an auction, firms will typically receive word from a placement agent or advisor.
This is where venture secondary direct buyers have to work fast and may have a hard time getting the information they need. The confidential nature of venture-backed companies makes the companies reluctant to share information with outsiders. This can stymie even the most thorough venture direct buyer. Depending on how much information is available, due diligence can take anywhere from two to six weeks.
“The largest challenge in this market is to really stick to the timetable of sellers,” says Werner Dreesbach, managing partner with Cipio Partners, which buys venture portfolios. When Cipio was looking at buying a portfolio from Infineon Ventures, “We had 30 direct companies in three funds and a time frame of two months between getting the first information at all and signing the contract,” Dreesbach says. “You have do to your technical due diligence, financial due diligence and set up an entity to purchase the funds.”
Potential buyers look at a portfolio and decide which assets (companies) they really want. “You focus on a small number of companies,” says one buyer. “Maybe 10% of the companies drive 90% of the value [of the portfolio].” Buyers may group them into tiers, with tier 1 companies being the companies they want the most. This is important when the buyer enters negotiations, because the potential buyer starts to build relationships with the companies it wants to buy. “We want [the portfolio companies] to feel they’re getting a good investor,” explains Gretchen Knoell of Lake Street Capital.
Sellers may choose a buyer based on familiarity with the industry or assets. Also, “probability of closure” is important. Sellers need to be assured that the buyer has the capital or the access to capital to get the deal done quickly. An agreement between buyers and sellers will also include clauses allowing buyers to walk away if certain company assets do not transfer. Once a price has been established, the two parties agree on a time period of exclusivity based on the price before the signing of the deal.
The buyer signs an agreement with the seller, but the buyer doesn’t have control of all the assets. They still have to transfer from one stakeholder to the other. There is a big gap of time between the signing of the agreement and the actual close (or completed transfer of all assets).
Some assets may transfer immediately, while some may take between 60 to 90 days. Each company in the venture portfolio has a different contract with its VC and different rules govern the transfer of interests. Some companies have a right of first refusal and some companies require that other primary venture investors be given the opportunity to buy the stakes. As there is no industry standard transfer restriction in the venture market, companies can have whatever transfer restrictions they want.
Here is where a buyer that has or builds relationships with a company may reap a good reward. “We had one deal where our relationships paid off,” Knoell says. “One company had right of first refusal that allowed us to win a deal at a lower price. We did not win the bid but the winner had an issue over transfer restrictions. That’s where it’s more than just price.”
Once the buyer has the assets, they must be managed to liquidity. Here is where a secondary direct buyer needs operating experience. They are now essentially VCs and need to be hands on. “We try to add value through our management expertise,” says Hans Swildens of Industry Ventures. “We make sure there are the right managers at the right levels. We make sure that the management team is appropriately staffed and we work with the CEO on that. Having an operating background gives us an advantage there.”