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Term Sheet — Wednesday, March 1

EXITING THE EXIT

Good morning, Term Sheet readers. Laura Entis here, filling in for Erin while she’s on vacation. (Please continue to email me any deal listings: laura.entis@fortune.com)

As Erin mentioned yesterday, we’ll be running guest columns while she’s away. Today’s edition is from Sapphire Ventures general partner Nino Marakovic and limited partner Beezer Clarkson, who debate what makes for a better exit—an IPO or an acquisition?

Everyone in the venture-backed technology industry—entrepreneurs, venture capitalists, and limited partners—can probably agree that a healthy exit market is critical. Without sufficient exits, there would be a liquidity gap, which would negatively impact everyone. Yet not all “successful exits” affect all the players in the venture world the same way. Accordingly, there are different views on the best path to liquidity.

Take IPOs. They’ve historically generated amazing returns for employees and investors—more than M&A exits.

But that has changed in recent years. In 2016, of the 513 VC-backed tech exits in the U.S., 499 were M&A events. These M&A exits represent $56.7 billion, versus the mere $9.6 billion exit value from the year’s 14 tech IPOs. Further, for first time since 2008, not a single tech IPO in 2016 saw more than $250 million raised, and only four offerings raised more than $100 million, according to PitchBook data analysis by Sapphire Ventures.

Further, much of the appreciation that used to happen in the public markets is now happening in the private markets, given the increase in late stage investing and “private IPOs.” This can benefit investors able to sell secondary interests, but those deals rarely match the historical returns of a ‘successful’ IPO and ensuing run in the public market markets.

This means an IPO today might not have the same impact for investors, employees and LPs that it used to. Its impact depends on how much of the company’s appreciation happened in the private markets versus the public. Below, we debate the pros and cons. (Sapphire Ventures has a direct growth-stage fund that invests in expansion-stage IT companies as well as an evergreen vehicle that makes LP investments into early-stage venture funds.)

Marakovic: We always seek to invest in companies that we believe will be able to go public one day, and as a result, we have a disproportionately high IPO exit ratio relative to the industry. Of the 41 exits we’ve had since becoming an independent entity six years ago, 16 were IPOs and 25 were M&A.

Typically, the IPO is not just a more successful return from a financial perspective, but it’s an indicator of success in itself: It’s validation that public investors also believe the company is viable and sustainable. Moreover, it puts the company in a better position to really disrupt an industry.  And I think that’s what it’s all about for us—helping create companies that are meaningful and reshape industries.

Clarkson: LPs also care deeply about doing right by the entrepreneur and the company.

IPOs are a very important part of the venture ecosystem. And something LPs look for from the venture funds in which they invest. With that said, when venture funds look to make distributions post-IPO back to their LPs, many LPs prefer cash to receiving public stock. Cash is simpler and cleaner. Not all LPs have internal public stock expertise, so knowing when to hold or sell stock can be complicated or expensive if they have to pay others for guidance.

In addition, some LPs have an internal rule that when they get stock, they must sell it. In practice what happens then is that the stock price can shift between the time the stock is distributed and the time the LPs sell it. If the stock price drops in that time, the carry paid to the venture fund does not take the price the LP sells at into account. Rather the carry is calculated based on a rule agreed upon in advance, for example a five or ten day rolling average pre-distribution.

So if by the time the LP sells the stock is lower, the LP has lost money. On the other hand, the stock price could go up and the LP can gain additional benefit.

We understand that venture funds might have different views on how long to hold a public stock. For example, many early-stage VCs who have been with a company since its first venture round, view exiting at the IPO or as soon as possible as a rational business decision. For later-stage venture funds, longer hold times and even buying public stock on occasion can be appropriate. We encourage all of our funds to have a clear policy on public stock, for everyone’s benefit.

Marakovic: Many years back, in advance of our first IPO, we surveyed our friends in the VC industry (general and limited partners) to see what best practices were out there and saw that only a very few firms have real policies in place.

We decided to implement our own that, while providing for exceptions, created a standard framework to sell up to a third of our shares at the first opportunity (typically a secondary stock sale by company or open market sale post-lock up) with the remainder staged over 12 to 24 months, in an orderly fashion so as to not negatively affect the company. There are exceptions, and in all cases the over-riding objective is to do right by the company. VCs often tend to hold public shares too long, as venture capital is a hit-driven business and you want to ride your winners for as long as possible.

Clarkson: M&A exits can make for great exits too. The cash M&A exit is, for the most part (escrow aside), a real exit—i.e. you get cash back from the investment and everyone knows exactly what it’s worth.

Marakovic: There is another interesting set of tensions at play here—maximizing IRR versus multiple. While VCs pay attention to IRR, they get paid on multiple of cash generated. And longer holding periods can increase the deal multiple but tend to reduce IRR. In our experience, most LPs will focus on multiple of capital over IRR because of their long-term perspective and willingness to maximize value over time. However, some LPs prefer having cash available to re-invest sooner rather than enduring a long tail holding period that does not accrete meaningful additional value in the portfolio. If an LP has great deal flow and access, it may be preferable to re-invest the returned cash into other strong fund opportunities that have higher expected value.

So we strive for the IPO (even if we are not selling shares in the IPO) and hope that companies will go on and do even greater things post-IPO. A good cash M&A exit that is based on a strong multiple of forward earnings keeps cash coming back and is a very close second.

It’s worth noting that neither exit is a real exit for entrepreneurs and CEOs. For the most part, they can’t sell their shares in the IPO and then have significant constraints put on their ability to sell shares in the public market. In the M&A scenario, key employees are often tied to the acquiring entity for a while through various mechanisms including re-vesting and retention grants. On top of that, this is the entrepreneur’s only egg in the basket, where VC and LP decisions are driven by broader portfolio management.

THE LATEST FROM FORTUNE…

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Meet YouTube TV.

Inside Target’s $7 billion plan to revamp its stores.

Harvard Business School is a breeding ground for unicorn founders.

From selling records on the street to working with Jay Z.

…AND ELSEWHERE

The “CEO whisperer” making founders cry. How the New York Times is clawing its way into the future. The brilliant (but illegal) plan that could stop drone terrorism. The Metropolitan Museum of Art is getting a new director. Why Uber is the perfect villain.

VENTURE DEALS

Ofo, a Chinese bike-sharing startup, raised $450 million in funding at a valuation of more than $1 billion, according to Bloomberg. Read more.

Kensho, a Cambridge, Mass. provider of analytical tools for capital markets, raised $50 million in a Series B funding, according to Forbes. S&P led the round, and was joined by Goldman Sachs, JPMorgan Chase, Bank of America Merrill Lynch, Morgan Stanley, Citigroup and Wells Fargo.  Read more.

Pypestream, a New York developer of an app that allows brands and businesses to interact with customers via chat, raised $15 million funding. Rick Braddock, the former president and COO of Citibank, The Chatterjee Group, and an unnamed global hedge fund led the round.

Medisafe, a Boston-based personalized medication management platform, raised $14.5 million in Series B funding. Octopus Ventures led the round, and was joined by M Ventures[Update: A previous version of this article misstated where Medisafe is based.]

WorkJam, a Montreal developer of software that allows shift-based and hourly workers to manage their schedules, raised $12 million in funding from Lerer Hippeau Ventures, Blumberg Capital, Founder Collective, and NovelTMT, according to TechCrunch. Read more.

Incorta, a San Mateo, Calif. analytics platform, raised $10 million in Series A funding. GV led the round.

ZoneFox, an Edinburgh  cyber security firm, raised £3.6 million ($4.4 million) in Series A funding. Archangels, The Scottish Investment Bank, and TriCap led the round. Read more.

Starsky Robotics, a San Francisco self-driving truck startup, raised $3.75 million from Y Combinator, Sam Altman, Trucks VC, Data Collective, and several other angel investors. Read more at Fortune.

Polarity, a Washington, D.C. developer of a commercial human memory-augmentation and collaboration platform, raised $3.5 million in funding. Strategic Cyber Ventures led the round.

Lumavate, a Carmel, Ind. cloud software platform operator, raised $2 million in funding. Angel investor Don Brown led the round, and was joined by Elevate Ventures, Allos Ventures, 4G Ventures, and Collina Ventures.

Enersize OY, a Finnish energy efficiency monitoring company, raised an undisclosed amount in funding from Scania Growth Capital.

Moving Analytics, a Marina Del Rey, Calif. developer of digital rehabilitation services for patient rehab programs, raised an undisclosed amount in funding OCA Ventures.

Tealium, a San Diego, Calif. provider of real-time customer data and enterprise tag management solutions, raised an undisclosed amount of funding from Citi Ventures.

HEALTH + LIFE SCIENCES DEALS

Muse Bio, a Denver, Colo. genome engineering company, raised $23 million in Series B funding. Venrock led the round, and was joined by Foresite Capital, Paladin Capital, NanoDimension, and Spruce/MLS.

OMEICOS Therapeutics, a Berlin-based biopharmaceutical company developing therapeutics for the prevention and treatment of cardiovascular diseases, raised €8.3 million ($8.7 million) in Series B funding. Vesalius Biocapital II S.A. SICAR and SMS Company Group led the round, with participation from KFW Group, VC Fonds Technologie Berlin, High-Tech Gründerfonds II GmbH & Co. KG (HTGF), The Falck Revocable Trust, and Ascenion GmbH.

Exonics Therapeutics, a Dallas developer of gene editing technologies such as CRISPR/Cas9 to permanently correct a majority of mutations causing Duchenne muscular dystrophy, raised $5 million in seed funding from CureDuchenne Ventures.

PRIVATE EQUITY DEALS

• Airbus (ENXTPA:AIR) sold the majority of its stake in Defence Electronics to KKR (NYSE:KKR) in a deal valued at €1.1 billion ($1.2 billion), according to Reuters. Read more.

• Veritas Capital agreed to acquire Chicago Bridge & Iron Company’s (NYSE:CBI) Capital Services business for $755 million in cash.

• America’s Auto Auction, a wholesale automobile auction company backed by Trinity Hunt Partners, acquired Auction Broadcasting Company, an Indianapolis-based auto auction company.

• Red Hawk Fire & Security, a Boca Raton, Fla. fire safety systems installer backed by Comvest Partners, acquired Integrated Systems of Florida, a Oldsmar, Fla. security systems integration company. Financial terms weren’t disclosed.

• MetaSource, a LaSalle Capital portfolio company, acquired Orion Financial Group, a Dallas provider of mortgage assignments and lien releases. Financial terms weren’t disclosed.

Brook Venture Partners has promoted Brennan Mulcahey, Jonathan Green, and Kyle Stanbro to partners. In addition, the firm has also promoted Ryan Wittman and Amit Nagdev to associates.

Chris Paldino has joined Hidden Harbor Capital Partners as a founding partner. Additionally, Andrew Joy has joined the firm as a principal.

The Hilb Group, a Richmond, Va. provider of insurance brokerage services backed by ABRY Partners, acquired Charlotte Insurance, a Charlotte, N.C. insurance brokerage, and the group benefits division of Sapers & Wallack, a Newton, Mass.-based financial advisory service.

Hygiena, which is backed by Warburg Pincus, acquired DuPont Diagnostics, a provider of global food safety diagnostics, from DuPont (NYSE: DD). Financial terms weren’t disclosed.

OBI4wan, a Dutch SaaS social media monitoring company, acquired Buzzcapture, an Amsterdam reputation management agency. Financial terms weren’t disclosed.

• Technology Crossover Ventures acquired Retail Merchant Services, a U.K. provider of bank transaction processing services. Financial terms weren’t disclosed.

• Highlander Partners acquired Hi-Tech Industries, a Farmington, Mich. provider of car care product accessories and specialty aerosols to the automotive appearance industry.

• Beauty Industry Group, a Salt Lake City beauty product company backed by Gauge Capital, invested in International Designs Corporation, a Hollywood, Fla. provider of hair extensions.

OTHER DEALS

• General Motors (NYSE:GM) plans to sell its 58% stake in General Motors East Africa to Isuzu (TSE:7202). Read more at Fortune.

BCBG Max Azria Group, a Vernon, Calif.-based designer of women’s clothing and accessories, has filed for bankruptcy. Read more at Fortune.

Time Inc. (NYSE:TIME), the publisher of titles including Fortune, Time, and People, is requesting bids from potential acquirers by the end of next week, according to the New York Times. Read more

• Onex (TSX:ONEX), in its sale of USI Insurance Serviceshas received bids from Carlyle Group (NasdaqGS:CG), CVC Capital Partners, and KKR (NYSE:KKR), according to Bloomberg. The offers value the Valhalla, N.Y.-based brokerage at more than $4 billion. Onex purchased USI Insurance in 2012 for $2.3 billion. Read more.

• Maxwell Technologies (Nasdaq: MXWL) acquired Nesscap (TSXV:NCE) for $23.175 million.

• YM Inc, a Toronto-based operator of apparel stores in Canada and the U.S., is preparing a bid to acquire Irvine, Calif.-based teen retailer Wet Seals intellectual property, according to Reuters. Wet Seal filed for bankruptcy in February. Read more.

• Comcast (Nasdaq:CMCS.A) agreed to purchase the 49% of Universal Studios Japan it does not already own for ¥254.8 billion ($2.27 billion), according to Reuters. The deal values the Japanese theme park operator at ¥840 billion yen ($7.5 billion), including debt. Read more.

IPOS

Gardner Denver, a Milwaukee-based industrial machinery manufacturer owned by KKR (NYSE:KKR), has filed to go public.

Hamilton Lane, a Bala Cynwyd, Pa. alternative asset manager, raised $190 million by offering 11.9 million at $16, the midpoint of its range. The company plans to trade on the Nasdaq under the symbol HLNE. J.P. Morgan and Morgan Stanley are the joint bookrunners on the deal.

EXITS

• Related Companies purchased TowerBrook Capital Partners and GI Partners’ stake in Ladder Capital (NYSE:LADR), along with shares from other stakeholders, in a deal valued at $80 million.

FIRMS + FUNDS

Lux Capital, a New York-based venture capital firm, raised $400 million for its fifth fund.

PEOPLE

• Renata Quintini has joined Lux Capital as an investing partner.

Brook Venture Partners has promoted Brennan Mulcahey, Jonathan Green, and Kyle Stanbro to partners. The firm also promoted Ryan Wittman and Amit Nagdev to associates.

Chris Paldino has joined Hidden Harbor Capital Partners as a founding partner, and Andrew Joy has joined the firm as a principal.

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