Should Venture Capitalist Sell Out To Secondary Firms?

Every once in a while, I read something and go "huh?"  The most recent was the report that 52.9% of venture capitalist think that VC is broken.

Per my post, I don’t think the model is broken and am disappointed in my colleagues who think it is. 

Today, I read another article about VC being broken in BusinessWeek.  The author believes that the VC model would work better if early-stage investors bought early and sold out to secondary funds before the companies ultimate exit.  He then argues these secondary investors make better board members of later-stage companies.  Huh?

This is absolutely the wrong thing to do.  It make no sense.  This why:

1. Secondary Buyers Never Pay Full Value for Shares.  I’ve seen a lot of secondary deals and even in the "named" transactions (Facebook,etc.) the secondary guys enter in a 50% discount to current value of the shares.  In other words, whatever value I’m carrying the investment at, I should expect to get 50 cents on the buck.  I understand the strategy from the secondaries and would do the same if I were them, but that certainly doesn’t help my return.  From an investor (my investors) standpoint, I’d always be selling for half of value;

2.  There Are Very Few Companies that Fit the Profile.  All of the author’s examples talk about the extreme outliers in VC investing, so at best this is an edge case scenario.  In most cases, the companies aren’t in a position to attract a secondary buyer as they are still too risky;

3. VCs Should Hold Their Winners.  The corollary for number 2, above is that VCs make a massively disproportionate amount of their returns from these Black Swans and to sell them early would depress overall VC returns.  As the model has been shown to work, one needs to hold their winners, not sell them too early; and

4. VCs Make Effective Board Members.  I don’t know all the secondary funds, but the ones that I do are financial engineers, not company runners.  I would agree that our specialty is early-stage counsel, but that doesn’t mean that we have nothing to add later in the equation and I’ve seen no evidence that secondary buyers have more to add than VCs. 

I applaud anyone thinking out of the box to improve the VC industry, as clearly I’m interested in VC success, but this is not the way to approach the problems.  Yes, some VCs are broken, but I still think the model works.