Sunday, October 10, 2010
The New Exit in Venture Capital, by Darian M. Ibrahim, University of Wisconsin Law School, was recently posted on SSRN. Here is the abstract:
This Article is the first to explore a third exit option in venture capital to supplement IPOs and trade sales: secondary markets for the sale of individual ownership interests in start-ups and venture capital funds. The Article begins by explaining how high levels of investor lock-in and illiquidity are embedded in the VC model and have been made worse by negative and perhaps lasting changes in IPO markets. While most private companies have no market for their shares and therefore must rely on legal solutions to the problems caused by investor lock-in, this Article reveals the unique development of a market solution for investors in private start-ups and VC funds. These secondary markets that are emerging in venture capital can increase liquidity for investors, reduce agency costs in start-up and VC fund governance, and mitigate VC-entrepreneur conflicts over traditional exit decisions. These secondary markets also have limitations, however, including that they can mute high-powered incentives for performance, present high levels of information asymmetry and transaction costs, and face legal impediments to growth. The emergence of electronic marketplaces will help to facilitate transactions and overcome some of these limitations, but certain securities and tax laws may need to be revisited as secondary markets continue to develop.