Exit Strategy of VC Firms in India — Special Focus: Secondary Sales

Richard Branson, the founder of the Virgin Group and owner of more than 400 companies worldwide, once had the following to say in the context of venture capital businesses:

“They are like buses — there is always another one coming.”

Be that as it may, like many other growth cycles that have been upended by the ongoing pandemic, the state of venture capital (VC) and private equity (PE) investments in India has hit a rather uneven patch.

Throughout 2020, the number of PE/VC exits kept dwindling and declined to a six-year-low of $6bn in aggregate deal value. This was perhaps a windfall from the pandemic and the desire of investors to focus on management of funds rather than deal-making.

But since we entered 2021, there has been a noticeable increase in the number of PE/VC exits, particularly in the Jan-Mar quarter this year — almost double the previous year.

Not that PE/VCs exiting from businesses is a starting development. But the manner and circumstances in which they pull out of these ventures is quite telling.

For instance, recently KKR bought out Sequoia’s holding in Vini Cosmetics for $200m to gain a 55% controlling stake in the company. The cosmetic maker which sells the Fogg brand of deodorants, among other products will continue to retain its management. But what’s interesting is Sequoia’s exit from this deal and how it is different from its other exits and investments in the recent past.

Let’s delve into the details.

The Exit Strategy

Since the growth of VCs and PEs became wide scale in the ’90s, they have emerged as a mainstream asset class for companies. Getting in at the bottom of the growth cycle and having their returns increase manifold over time is the modus operandi of these firms.

But these returns are only received once they exit their investments. Therefore, the exit strategy becomes the most defining part of their operation. Usually there are a few ways in which VC/PE firms exit or sell their stakes in companies they have invested in.

One is through IPOs which are a form of open-market exits. When the company sells its stock to the public, it unlocks multiple new avenues for investments which provides PEs/VCs with a window for potential monetisation.

Many of the IPOs are, in fact, PE/VC-backed strategic events to help maximise their returns. Around 55% of all IPOs in 2020 were dominated by exits of PE/VC firms, which was a record in the last five years.

Another way is through secondary sales. This way, VCs sell their shares to another strategic or financial investor (“the secondary”).

Usually, these secondaries are other VC/PE firms. The Times of India reported that VC exits via secondary sales stood at $489m from 13 deals in the Jan-Mar quarter this year compared to merely $25m in the same quarter last year.

The Secondary Sales Pitch

One of the advantages of secondary deals lies in the fact that they enable a company to stay private for longer.

In addition, secondary buyers have a good chance of purchasing shares at a heavy discount. This is especially true where existing investors are in a rush to get out or are under an increasing mandate to exit their positions in the company.

Flipkart’s secondary sale to Walmart in 2018 marked an inflection point in the Indian PE/VC exit landscape. It gave impetus to a number of companies (e.g. Ola, Zomato, BigBasket, Lenskart, Paytm, Policybazaar etc.) to pursue their own secondary sales and offer much-needed returns to their backers.

IPOs may be significant and momentous vehicles to boost enterprise valuation but they are massive and complicated affairs which take months to organise. Secondary sales provide a useful alternative in these scenarios to cash-strapped investors who merit justifiable rewards for their initial support and financing of these startups.

True, 2020 saw a slight decline in secondary deals, perhaps partly due to the hamstrung valuations in pandemic-era which would be unsuitable for returns. Things may likely improve going forward.

Success of Playing Second Choice?

Although secondary share sales have emerged as a viable exit for investors over the last few years, one may question whether they are increasing at a promising pace. Last year, SoftBank said that the firm has about $13bn in “unspent capital” and it was scouting for secondary deals to invest in India. Seems like a bulk of the voyage is shipping empty.

Open market exits (like IPOs) still make up a big chunk of the exit trajectory (~50%).

This is also a cyclical process, when you think about it. Without more sustained funding, the startups’ growth and performance expectation gets enhanced, thereby taking them longer to achieve the desired scale that provides adequate returns on investments.

Investments into growth-stage tech startups have also risen considering their heightened value projections. Nearly half of all VC investments in India last year went into the consumer tech sector (foodtech, edtech, gaming etc.), followed by SaaS and fintech. The three sectors together amassed more than 75% of the total investments.

Sequoia has also moved away from the non-tech-led consumer-facing businesses over the years. The Vini sale is yet another proof of the diminished presence that non-tech-led investments are allocated in the portfolio of the PE firm. Which is more notable considering the fact that Sequoia has opted for a full exit here as opposed to its partial exits in Byju’s and Indigo Paints where it still holds stakes.

Investor diligence towards exit options may be gradually scaffolding. Higher regulatory and compliance costs haven’t particularly helped in keeping up with the growth momentum of startups either. Incentivised exit machinery coupled with ease of compliance is the likely way to go to improve the exit landscape in India. One man’s exit is another man’s opportunity, as Sir Richard Branson would have us believe.

(Originally published June 22nd 2021 in transfin.in)