Buyout Funds and Venture Capital Exits May Top 2020’s Record

Buyout and VC exits are on a tear this year with record IPOs. How long will it last and are valuations getting too hot?

We spoke previously about the rapid run-up in venture capital (VC) deal-making going on this year in North America, but GPs are exiting companies as fast as they’re adding them to their portfolios. Buyout and VC funds have already exited more than $387bn in positions since the start of the year – more than half of 2020’s total, and ahead of any year from at least the past decade (Fig. 1).

The main driver here is the exit environment, or the overall health of the equity market’s influence on portfolio company valuations, which is something 40% of investors cited in our 2020 survey as a key challenge to return generation. Of course, those respondents were surveyed when levels of economic uncertainty were peaking and vaccine roll-outs were a faint light at the end of the tunnel, not the latest Spring 2021 fashion. Indeed, both the deal-making and exit environments crashed in the second quarter of 2020, particularly for buyouts. VC trade sales buoyed activity, as depressed pricing made corporate synergies a better route to survival.

The vaccine-led recovery is likely to change investors’ tune, however. The PrEQIn indices for both buyout (Fig. 2) and VC (Fig. 3) funds demonstrate that returns, here shown as rolling 12-month percentage changes, rise with the volume of exits. This effect, led by the realization of investment returns, is more pronounced for VC funds than buyouts, reflecting the relatively higher risk levels in the VC space.

VC exits over the past few quarters were headlined by several large deals which greatly contributed to the bump in deal value. The biggest of these was the direct listing of cryptocurrency exchange platform Coinbase Global, which sold $43.8bn in public equity shares last April. Other exits, such as the $27.7bn trade sale of communications platform Slack Technologies to Salesforce.com in Q4 2020, and Teladoc Health’s $18.5bn purchase of data science platform Livongo Health last August, skewed the data considerably upward.

In the case of IPOs, sellers are likely to have done better than buyers. IPO shares can give more insight into how these investments pay off – and for this year’s IPOs, share buyers have had mixed fortunes at best. As of 31 May, the Renaissance US IPO Index was down 4.4% since the start of 2021 and down almost 8% in the three months ending May. Conversely, the index is up 69.2% over the trailing one-year period, reflecting gains of 2020’s post-IPO market.

Shares of Coinbase Global initially hit the market around $350 but are trading at $224 at the time of writing, a 34.5% decline. While this is not entirely indicative of the company’s long-term prospects, it does raise the question of whether some of these valuations are a bit overblown.

This question was posed to Salesforce CEO Marc Benioff in a recent interview with Yahoo! Finance following its first-quarter earnings release. Benioff responded by emphasizing the company’s longer-term plan for the acquisition, believing the price paid will be worth the synergies.

What does the future hold? The average deal size, particularly for VC funds, has accelerated over the past few years, and some funds are feeling the pressure to tap as much value as they can out of portfolio companies to meet client return expectations. Chief among those expectations is performance. These entry valuations will set the tone for exit targets, both in time and value. With both side of deals on the rise, investors should expect horizon IRRs to slip compared to their historical numbers, or see capital locked up longer in hopes of a bigger payday down the road.