Strategic Exits in Secondary Venture Capital Markets

49 Pages Posted: 29 Jan 2020

See all articles by Guillaume Andrieu

Guillaume Andrieu

Montpellier Business School

Alexander Peter Groh

EMLYON Business School

Date Written: December 10, 2019

Abstract

The market for secondary venture capital transactions provides a way for investors to obtain liquidity if the investee start-up corporation has not yet reached sufficient maturity for an IPO. It also creates divestment opportunities for badly performing ventures that investors would rather abandon. We analyze the way in which the opportunistic behavior and liquidity constraints of venture capital funds channel deal flow into the secondary venture capital market. Such opportunistic behavior leads to the strategic exit of seed financing venture capitalists. These exits enlarge investors' opportunity set of strategies and therefore affect the deal terms with entrepreneurs. In this paper, we show that two contracts are possible in a world with financially constrained venture capital investors, staged investments, and premature divestment opportunities. Both contracts have their disadvantages. With the first, the venture capitalist will never liquidate a project, even if it is a lemon, but will instead engage in a secondary transaction. With the second contract, although lemons will be systematically abandoned, high-quality ventures may also be liquidated. Entrepreneurs need to consider these effects when aiming to maximize their benefits and must trade off the contract parameters accordingly. Our model provides guidance to entrepreneurs in this respect, helps to explain deal flow into the secondary venture capital market, and offers several empirical predictions.

Keywords: Secondary Venture Capital Market, Entrepreneurial Finance, Venture Capital, Moral Hazards

JEL Classification: D81, G24, G32, L26

Suggested Citation

Andrieu, Guillaume and Groh, Alexander Peter, Strategic Exits in Secondary Venture Capital Markets (December 10, 2019). Available at SSRN: https://ssrn.com/abstract=3515926 or http://dx.doi.org/10.2139/ssrn.3515926

Guillaume Andrieu

Montpellier Business School ( email )

2300, Avenue des Moulins
Montpellier, 34185
France
+33467102864 (Phone)

HOME PAGE: http://www.supdeco-montpellier.com

Alexander Peter Groh (Contact Author)

EMLYON Business School ( email )

23 Avenue Guy de Collongue
Ecully, 69132
France

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