Venture funding is well-known to drive innovation and early-stage development in companies. However, many VC firms encounter challenges during the critical exit phase, where they must realize and distribute value to their investors (also known in the venture industry as “DPI” or distributions to paid-in capital). DPI is different from MOIC (multiple on invested capital) in that the former measures what the cash-on-cash return is for an investment made, while the latter measures only the multiple of original capital invested at a given point in time without any reference to whether the investment has been exited or not.
The "exit gap" highlights a significant issue. While VCs excel at identifying and nurturing businesses, they often lack the expertise needed to effectively manage initial public offerings (IPOs), mergers and acquisitions (M&A), and strategic secondary sales.
Why the Exit Gap Exists
This disparity arises from the traditional career paths of VCs. Many VCs come from entrepreneurship, technology, or consulting backgrounds, equipping them with skills in deal sourcing, strategic planning, and portfolio management. However, few have practical experience in exits, which require in-depth knowledge of transaction structuring, valuation, legal issues, and buyer dynamics—skills typically acquired through investment banking or corporate mergers and acquisitions experience.
A critical disconnect persists across the investment landscape, not just in India but globally—even in the U.S. Emotional attachment to portfolio companies (a hangover from a founder mentality) frequently leads to missed opportunities.
This issue is particularly stark in India, where successful exits hinge on acting when opportunities arise rather than waiting for ideal conditions. The pursuit (and promise) of outsized returns, such as a 50x MOIC, often backfires, resulting in diminished outcomes or lost chances altogether.
A Strategic Solution: Bringing Investment Bankers In-House
To bridge the exit gap, VC firms should integrate seasoned investment bankers into their teams. These professionals bring critical expertise and relationships with buy-side folks and corporate strategic acquisition decision-makers, developed through navigating complex financial transactions and executing successful liquidity events.
Here’s how in-house investment bankers can transform VC operations:
1. Strategic Insight: Investment bankers leverage their expertise in market timing, valuation trends, and competitive positioning to formulate effective exit strategies.
2. Robust Networks: Their affiliations with acquirers, institutional investors, and corporate executives facilitate access to prospects unavailable through conventional VC avenues.
3. Execution Excellence: Investment bankers ensure precision and efficiency in exit processes, from managing IPO logistics to navigating M&A complexities.
Building a “Holistic” VC Team
Integrating investment bankers into VC teams enables firms to proactively prepare for exits rather than relying on external advisors at the last minute. This approach fosters:
● Optimized Procedures: Early involvement aligns operations with exit goals, facilitating and simplifying due diligence and mitigating expensive mistakes.
● Enhanced Valuations: Investment bankers can devise competitive bidding environments and refine deal structures to optimize returns.
● Stronger LP Confidence: Demonstrating expertise in exits reassures investors of the firm’s ability to deliver meaningful outcomes.
Thriving in Tough Markets
In volatile economic climates, the case for in-house investment bankers becomes even stronger. During market downturns, initial public offerings diminish, and mergers and acquisitions activity may stall. Seasoned dealmakers can explore alternative paths, such as private equity buyouts, cross-border transactions, or strategic secondary sales, ensuring portfolio returns remain on track.
This adaptability differentiates firms in the competitive VC landscape, safeguarding returns even during challenging times.
Reevaluating the Competencies Required in Venture Capital
The VC sector is transforming, necessitating various expertise among teams. Incorporating investment bankers transcends merely addressing the exit gap; it is fundamentally about establishing a durable competitive advantage. Companies possessing this competence are more adept at steering startups toward successful outcomes, hence ensuring sustained value generation for investors.
A Sustainable Competitive Advantage
Integrating in-house investment bankers represents a paradigm shift for the VC industry. While not every firm will adopt this model, those that do gain a decisive edge. This strategy enables firms to consistently deliver returns, build LP confidence, and thrive in an uncertain market environment.
Addressing the exit gap encompasses more than merely financial results. It redefines the role of VC within the innovation ecosystem, enabling it to realize the complete potential of its portfolio businesses. By embracing this change, VCs can lead not just in funding disruptive ideas but in realizing their ultimate value.
(The above given article has been written by Sandiip Bhammer, Founder & Managing Partner, Green Frontier Capital)
