It’s clear that private financing markets and the exit markets continue to operate to a different set of multiples. This is one of the reasons why TVPI (projected PE fund returns) falls down towards DPI (actual fund returns) over time rather than DPI rising to TVPI.
Why do the markets operate differently? It’s simply due to how capital flows into each. Private equity firms raise funds of committed capital to deploy over 10+ years – they tend to react slowly to market conditions. The capital in public equity markets can move in and out every second – they tend to react (or overreact) very quickly. The exit markets are closer to if not in the public markets.
So what can happen for a private company is you raise capital in the shelter of the private markets, where multiples are high. Perhaps you raise subsequent rounds in the private markets, where multiples are higher. The private equity funds write up their investments because of a third party financing. TVPI goes up. All looks good.
But, as the company matures, maybe it loses a little bit of its luster, while simultaneously you move into the exit markets and the multiples decline. Sometimes a down round occurs first – according to Carta about 25%-40% of financings are down rounds. And, because of multiple compression, you ultimately sell for less than what you had anticipated – and this is when TVPI declines towards DPI.
This is a dynamic that inexperienced investors are less likely to “feel” because they haven’t navigated many companies through exit. There’s a bit of cognitive dissonance at the time of the investment because the public market comps are there for everyone to see, but the private financing comps become a signal that is louder than the public market comps.
At the end of the day, private financings can represent a false signal of a company’s value – there’s still plenty of room for down rounds to happen later. But, there are no more down or up rounds after an exit – so that’s the reality that matters the most.
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At layers 1 & 2 of vc, the DPI vs TVPI conversations took place day 13 and day 7 #23DaysOfOpenAIAtSXSW tagged “Larry Cheng”
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