It may be time to join the strip club.
That may not be good for our spam filters, but it’s true.
A strip sale of VC or PE holdings is an elegant solution to challenges investors face in a tough market.
They’re surging because it’s um, getting hot in here.
Well, the venture market is in rough shape. The data are mixed. Valuations have ticked up slightly from seed to Series C. But deal activity is still down 44% from two years ago; and 1H was the slowest half-year for deal activity since 2018. Rising valuations with lowered deal volume suggests that for the strongest companies, checkbooks are opening up; for everyone else, it’s cold out there.
That tough market is exposing many investors to “what now” thoughts. Balance sheet investors like family offices and CVCs feel this challenge most acutely.
They have may have sought strategic and commercial benefits from investments. But those investments may have run their course. Strategy may have changed. There may be pressure from the parent to return capital. Maybe it’s to re-set the investment program by generating fresh powder for further investments. Maybe it’s to reduce exposure overall.
But investors face a daunting picture, seemingly with three bad choices:
- Buy. Do they reinvest, support investees through lean times, and avoid the washout that would result from staying on the sidelines in pay-to-play rounds? Maybe. But that risks throwing good money after bad, and starving higher-priority investees of attention.
- Sell. Do they exit in a tough market? That ends the drip, drip, drip of bad news and it allows the investor to take their lumps all at once. It may be unpleasant, but it may be beneficial.
But selling may have other costs beyond the balance sheet hit. It may create reputational downside for the investor. It may lead to the loss of hoped-for strategic benefits from investees who no longer have a relationship with the investor.
And it may lead to further reputational exposure if the portfolio later turns around and generates a big win for the new owner. Nobody wants to be “that guy” at Pfizer who sold an asset for peanuts only to see the new owner sell it for $7 billion a year later. (Or “that guy” at Shell who gave away the “largest oil find in a decade” to Hess without knowing what they were sitting on.)
- Hold. Do they hunker down, hope for a turnaround, while keeping the checkbook closed? This may postpone a painful writedown from exiting positions in a very tough secondary market: venture pricing last year experienced the largest annual drop for any strategy in history.
But it may also lock in a slow bleed out of value as marks are written down or written off one by one, resulting in a steady drumbeat of bad news, arriving with the depressing regularity of junk mail.
There’s another way. A strip sale. Should you join the club? (We promised this dumb gag was going somewhere.)
A strip sale is a structured secondary sale of investment holdings, and it’s an awfully elegant solution to each of these challenges.
It attracts interest from new investors by providing discounted pricing up front, along with a preferred return, while maintaining a partial ownership stake. For the existing investor, it checks all the boxes:
- It provides them with partial liquidity now;
- It allows them to maintain influence and strategic benefits from the investees;
- In many cases it will obviate the need for a writedown because the existing investor participates in future upside;
- That future upside also provides “chump insurance” – the investor won’t be “that guy” because they’ll participate in future gains reaped by the new owner; and
- It eliminates the reputational cost of walking away from investees.
There’s a lot of nuance to this structure. (That’s what we do.)
But at its core, it’s an elegant way to check nearly all the boxes for an investor.
So, maybe it’s time to join the strip club.