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Liquidity for VCs: A New Exchange?

Posted on April 18, 2008

Update: Check out the comment from Dave McClure to hear his thoughts and read his clarification on the VC side of things (i.e. he does think that VCs are needed and helpful in the market but things more competition is a good thing - agreed!). He also links up his startup metrics which are getting better every day.

Liquidity for VCs and entrepreneurs is a topic that continually comes up. It has resurfaced in the last week due to the fact that public markets have pretty much been closed to startups for a while now leaving M&A as the primary liquidity event for entrepreneurs and VCs. This time Fred Wilson is the one kicking off the conversation about VC/entrepreneur liquidity.

Fred is worried about liquidity for obvious reasons but he also adds a new thought into the mix. He claims that web services that are exited via M&A to larger companies can languish inside their new corporate homes. This worries him as a user of the services and has pushed him to think about newpaths to liquidity even more.

The discussion over liquidity ramped up over the past week due in part to the interesting nature of the idea but also spurred along by the TechMeme effect (Fred event spoke about the topic on Yahoo’s Tech Ticker show). It has been interesting to see everyone’s opinion on the issue all the way from VCs should stop whining to agreement with Fred that a new form a liquidity needs to emerge. After absorbing all of the opinions across the web I decided I should chime in.

In fact, I actually wrote about a related topic back in October 2007 in response to my friend Dave McClure’s post. Dave argued that a market should be developed that would allow transparency and would disintermediate the VCs by allowing lenders and other investors to invest directly in startups while allowing startups to keep most, if not all, of their equity. As a student of finance and VC I found that idea very intriguing.

A large impediment to this type of market is solid data (and metrics). With good data debt and equity markets for startups could look like mortgage markets (ouch - bad example!) or the public markets. If you can look at historical startup data and understand the numbers enough to make a solid bet and know your chances of success an interesting market emerges. (Side effect - more actuarial jobs open up.)

Let’s say we can get the data and can figure out the right metrics, then what happens? Well, here is where things get a little tough. The SEC (or a new org like them) would probably want to step in and protect the individual investor from themselves. That’ll be a big brick wall in the way of innovation and it makes this idea a little more long term (man, I hate regulation). What can we do in the meantime then? This is where Fred’s post comes into play.

Fred argues that there should be another way for VCs to liquidate their positions and it could take the form of an exchange. This exchange would not be open to the general public and it would not disintermediate VCs like the one Dave wrote about back in October. What it would do is allow qualified/accredited investors (i.e. anyone except the average joe individual investor - this exclusion eliminates the need for SEC oversight) to trade positions in private companies. This way VCs could trade their positions to others (like PE firms) rather than trying to bring a company public or sell their companies to larger companies.

It is an interesting idea and one that already happens informally as Fred mentions in his post. He simply thinks that a formal market may help. It turns out that this type of market is already springing up in various forms surprisingly enough.

Goldman Sachs launched an exhange for private companies called GS TRuE - short fo Goldman Sachs Tradeable Unregistered Equity - about a year ago (this market is open only to Institutional Investors with $100mm or more in assets). Other networks like this are also popping up (like OPUS-5) and, according to this May 2007 WSJ story, the Nasdaq is planning on launching a smaller market for unregistered equities.

These markets will probably consolidate over time and then we’ll have our main market for unregistered equities which could be game changing. This isn’t quite what Dave was arguing for but it is a step towards it in many ways.

Even without the need for VC liquidity I think this would have come to bear. The increasing regulation of public companies is becoming unbearable for many managers and directors while also adding a lot of expenses into businesses. This is why so many large companies are choosing to be bought by PE firms and brought private (CDW is a great example).

This is a very exciting time for finance/business geeks like myself. Finance can be very innovative and we’re seeing the proof of that right now. I can’t wait to see how these new markets work out.

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4 Comments so far
  1. dave mcclure April 18, 2008 10:11 am

    nice piece eric.

    >>A large impediment to this type of market is solid data (and metrics).

    absolutely correct.

    btw, have i mentioned i’m very focused on improving Startup Metrics these days?

    also just to clarify: i’m not saying all VCs will be / should be disintermediated. however, there’s a lot of money out there that brings little value-added ROI.

    more competition for startups & their equity by the best & brightest of the VC community is not a bad thing, and actually strengthens the overall market, imho.

    regardless, any new forms of back-end liquidity are probably worth investigating further…

  2. Eric Olson April 18, 2008 11:28 am

    Thanks for the clarification Dave and I have been watching your startup metrics progress. ARGGGHHH! :-)

  3. Aziz Gilani April 19, 2008 11:24 am

    On a related note, entrepreneurs have been banding together to pool their equity stakes for years for diversification purposes through EB Exchange funds( On the VC side, there has always been a secondary market. I got to see Alan Feld from Vintage Ventures speak a few months ago who left me thinking that equity stakes are more liquid than most people believe.

  4. Eric Olson April 19, 2008 12:24 pm

    Thanks for the great info Aziz. I am starting to think that equity stakes are more liquid than people may think as well.