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Highlighting some singularities in Venture Capital acquisitions / investments

Three Studies for Figures at the Base of a Crucifixion - Francis Bacon
When a company acquires another company we usually distinguish between those cases where parties are “equal” (ordinary companies in the manufacturing and services sectors) and those cases where the buyer is a venture capital entity. It isn’t true, as some people say, that private equity investors only buy and sell like a mere speculator, because these companies also add value to the acquired company, improving its running in most of the cases. Furthermore, seen from a broader perspective, the venture capital entities increase the sources of finance in the market. In fact, as can be seen in the United States, which is by far the largest market in terms of venture capital financing, this sector helps companies to increase in number and productivity. That means, although it’s true that a divestment of the investor can harm the future of a company, in most cases the exit of the investor is not harmful.

For the basics on venture capital entities the lector can read the entry (in Spanish) “Primera aproximación a las entidades de capital riesgo – First approach to venture capital”, in which are the definitions of venture capital entity in Spain and fundraising, among others.

Due to the fact that venture capital entities seek to maximize the return on their investments, they tend to use financial leverage, since it’s the way to get more profit with less investment. These leveraged purchases are known as Leveraged Buy-Out (LBO)and they can take a variety of forms, as we have seen before in the entry (in Spanish) titled “Clases de compraventas apalancadas – Types of leveraged purchases”. Among all the types discussed in the mentioned entry, we can highlight the one known as Management Buy-Out (MBO), in which the acquirer consists not only by the venture capital entity, but also the former management team of the company purchased (the target). This type of leveraged purchase is very popular in the venture capital industry, because it allows the financial investor to not intervene in the management of the target. In consequence, the investor can benefit from the better knowledge of the managers in that particular company. Instead, when the participating companies are “equal”, the use of Management Buy-In (MBI) would be more common.

Unlike what happen in acquisitions between “ordinary” companies, ie between two or more industrial o service companies, the venture capital entities have a very  detailed (or more detailed) rules about what they can do or not. On these limitations we already talked in the entry (in Spanish) “Ley 25/2005 sobre las entidades de capital-riesgo – 25/2005 Spanish Act on venture capital entities”. Anyway, one of the most distinguishing peculiarities in venture capital, if not the most, is the divestment. The investor exit responds to the main and simple financial purpose of the buyer in that kind of operations. However, this isn’t regulated by laws, but by statutory covenants and, in most cases, by shareholders agreements. For practical purposes, we should keep in mind that trying to limit the divestment of a venture capital entity is like rejecting the investment.

In Spain venture capital can be accomplished by venture capital companies or through venture capital funds, as explained in the entry (in Spanish) “Constitución de las sociedades de capital-riesgo (SCR) y de fondos de capital riesgo FCR)”. 

Another peculiarity, as introduced with MBO’s, is that venture capital investors, typically prefer to keep key employees on staff. This leads them sign agreements of permanence with the managers or/and the founders. Finally, it’s important to know that venture capitalists (investors) usually will demand this list of rights and protections, among others: liquidation and dividend preferences, antidilution provisions, voting rights and co-sale rights (drag along and tag along clauses).