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1/ With the current wave of IPOs, many emerging VCs have the good fortune of choosing between selling their publicly traded shares or distributing shares “in-kind” to their LPs. Here are a few things for emerging VCs to consider when deciding between those options.
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2/ Our firm, Amplify Partners, doesn’t have a rule that dictates what we must do with public shares in every case. However, we strongly prefer to distribute shares to our LPs vs. selling shares and distributing cash. Here’s why:
3/ Distributing stock gives LPs choice. They can decide if they prefer to hold or sell a stock, and that option value is huge. Selling stock at the fund level denies them that option - and that is a big deal where taxes are concerned.
4/ Selling stock and distributing cash probably means a big tax bill, however, distributing stock is an option for a tax bill later. Any taxable LP that plans to hold, gift, or donate appreciated public stock will definitely prefer to receive shares instead of cash + a tax bill.
5/ In the past, many LPs preferred not to deal with the “hassle” of receiving and selling shares, but that’s far less common today. Amplify has a few LPs that prefer not to deal with stock, but they are in the far minority.
6/ Besides, It is now incredibly simple for LPs to receive, process and sell any stock they receive from GPs. Almost every investment bank has dedicated teams that focus exclusively on managing stock distributions for VC firms and their LPs.
7/ What do they do? They coordinate with your portfolio company and their legal counsel, clear restricted stock legends, receive stock from the transfer agent, and then sell or transfer shares to your LPs based on their individual preferences. Boring, but important mechanics.
8/ Now, we don’t always distribute shares. We’ve sold public stock to raise cash to fund follow-on investments. We've also sold stock when the total shares in question were small, and we chose not to send an insignificant amount of shares out to LPs.
9/ We also won't distribute illiquid stock or stock subject to an underwriter's lockup agreement since our LPs would also be bound by the terms of that agreement and couldn't sell the share. And LPs hate public stock they can't sell...
10/ In fact, NEVER distribute shares to your LPs that are not freely tradable. Your LP Agreement probably prevents you from doing it. But even if you are allowed, don’t do it! But why?
11/ Imagine distributing a stock at $50 per share and booking a huge return to your fund. High fives all around! But what if that stock drops to $10 per share before your LPs are allowed to sell it? Disaster. This actually happened at a fund in which I was an LP. Not good.
12/ Your experiences may differ slightly based on your fund structure, or the size & tax status of your LPs. But in all cases, save yourself a lot of headaches and be sure to discuss ALL these points with your key LPs well before you need to make these decisions.
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