Problem: The most common exit scenarios for startup companies are acquisitions, IPOs, or buyouts. In the world of venture capital funds, this optionality for exits provided to limited partners is even more limited.
Solution: If I were a limited partner that invested in a Venture Capital fund, how would I exit my investment early if I didn’t want to wait until the end of the fund’s life? Samir Kaji briefly alluded to this idea on twitter when he mused on the possibility of Venture Capital Secondary Markets:
You can read more about secondary markets here. To fully grasp the importance of this idea, it’s important to know how venture capital funds work. You can read more about Venture Capital’s history at this 1998 HBR article, or just see below for a summary from FundingPost:
A venture capital firm is a group of investors who gain income from wealthy people who want to grow their wealth. They take this money and use it to invest in more risky businesses than a traditional bank is willing to take on…. When individual investors entrust their money to a venture capital firm, the firm puts the money in a fund. This fund is then invested in several companies, with the expectation that the companies will be able to repay the money in around three to seven years. This money is repaid either when the company takes their business public and starts selling stocks and bonds, or when the company is acquired by another company. The money is then paid back to the venture capital firm, with interest. Sometimes, the money is repaid through shares of stock in the company. Once all of the money in a particular fund is returned, the money, with the interest earned, is then sent back to the investors. Of course, the firm takes a portion of the money as their fee.
The primary model of venture capital is get $xM from Limited Partners —> General partners deploy it —> wait for returns —> wait some more (5, 7, 10 years…) —> distribute returns from the fund! During that “waiting period” there is an untapped opportunity to allow and create a market for trading the rights for the distributed returns of a venture capital fund. This would allow for more liquidity for fund investors (especially if investors perceive that a fund is performing poorly) while also giving new investors the opportunity to buy into funds that they think are promising later in the fund’s lifecycle.
Venture capital is a $280 billion market: transacting just 1% of this with a 10% trading fee (or less) could easily create a billion dollar business. You can read more about VC secondaries in industry ventures’ posts on “The Third Exit Option” and “How Big is the VC Secondaries Market.”
Monetization: Transaction fees generated through the platform.
Contributed by: Michael Bervell (Billion Dollar Startup Ideas)