These firms, most of which did not exist 10 years ago, specialize in buying stakes in private companies from VC firms. Some examples include Saints Ventures and W Capital Partners, which are among the most successful firms this decade. Secondary firms now account for roughly 3% of the VC market, but their clout is increasing as they do more deals. San Francisco-based Saints now has more A-list portfolio companies than most traditional VC firms. Its investments include Facebook, eHarmony, and QuinStreet.
Increased Return It helps that increasingly, many VCs are open to selling their positions to secondary firms. While selling early will lessen the long-term value of investments that become hits, it could increase a VC's actual return on investment by letting them realize returns much faster -- say, three years rather than 10 years.
What's more, increased dependence on secondary investors will let VC partners focus on what they do best. Different skills are required for an A-round investor than for a late-stage investor. A venture capital firm should deliver and focus on its core competency and move on. Just like startups change CEOs as they mature, shouldn't companies change VCs as they mature? If there is a good startup CEO, shouldn't there also be good startup VCs? Some people can take a company from startup idea to billion-dollar business, but most need to be replaced along the way -- this is true for both management teams and board members.
Early-stage VCs could focus on early-stage issues and later-stage VCs could focus on later-stage issues. Their investing timelines could be shorter, they can better plan for the future, and they'll need to keep less undeployed capital, or "dry powder," on reserve. They'll probably also do more deals.
My guess is that firms that invest in an A round might not necessarily invest in the B round. Instead, they might look to unload some or all of their shares in the C round.
Take Gains Early I know a few angels who already follow this model. One sold half his interest to a particular VC in the C round and later sold the rest of his interest to that same VC. He made about 250% in three years. That's not bad -- especially when compared with the current market. Sure, he may miss a big pop in share price. But he's become a very successful investor through his strategy of taking gains early.
Why don't more VCs and angels follow this strategy? As an angel, I have a lot of good advice for a company that's just getting off the ground, but if I'm intellectually honest, I don't usually add much value after the second venture round. Still, I haven't followed the model I outline here. Maybe it's time I should.
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