When venture capital meets the public market: what investors need to know

There is a moment in the life of many successful private companies when the venture capitalists who backed them from the beginning decide it is time to move on. They have taken the company from an idea to a functioning business, shepherded it through funding rounds, helped recruit senior management, and watched the valuation climb on paper. Now they want liquidity. They want the returns they promised their own investors. And the most common route to that liquidity is a public market listing.

For retail investors watching from the outside, this moment can look like an invitation. A company arriving on a public exchange carries the credibility of institutional backing. It has a story, a pitch, often a track record of revenue growth. It feels like the hard work has already been done. But the relationship between venture capital and public markets is more complicated than it first appears, and the investors who understand that complexity tend to make better decisions than those who do not.

Venture capital firms raise money from pension funds, family offices, endowments and other institutions, and they promise those investors returns over a defined period, typically ten years. The structure matters because it creates a clock. When that clock starts running down, VC-backed companies need to find an exit, and a stock market listing is the cleanest one. It gives early backers a way to realise their gains, and it gives the company access to new capital it can use to fund continued growth. What it does not necessarily do is make the company a good investment for the person buying shares on the first day of trading.

The most straightforward route to market is a traditional initial public offering, where the company sells new shares to institutional investors at an agreed price and then lists on an exchange. This is the mechanism behind most of the high-profile names that have arrived on the London Stock Exchange or AIM over the past decade. There are also more unusual routes. A reverse merger involves a private company acquiring a publicly listed shell, effectively buying its way onto a stock market without going through the full IPO process. Special purpose acquisition companies, better known as SPACs, raised considerable excitement in the United States in the early 2020s: blank-cheque vehicles that list first and then go hunting for a private company to merge with. Each of these routes has different implications for how shares are priced, how much due diligence public investors can do, and how the company’s early backers exit their positions.

The tension between venture capital investors and public market investors comes down to time horizon and information. A VC fund has spent years inside a business. It knows the management team, has seen the internal financials, understands the product roadmap and the competitive landscape. A retail investor buying shares on the first day of trading has a prospectus and a set of management presentations. The information gap is significant, and it tends to favour the seller rather than the buyer.

Deliveroo’s London IPO in March 2021 became the defining cautionary tale of that era. The company arrived at a valuation of around 7.6 billion pounds, backed by heavyweight venture capital names and accompanied by considerable fanfare. Within hours of trading beginning, the share price had fallen sharply. Within a year it had lost more than three-quarters of its value from the IPO price. The issues were not entirely hidden: Deliveroo had never made a profit, its business model depended on the continued classification of riders as independent contractors rather than employees, and some large institutional investors had publicly declined to participate in the float on governance grounds. But the promotional energy around the listing drowned out those concerns for many retail buyers.

Fever-Tree tells a very different story. The tonic water brand listed on AIM in 2014, several years after it was founded, and did so at a valuation that, by the standards of the company it would become, looks almost apologetic in hindsight. There was no fanfare, no enormous institutional roadshow, no sense that the company was racing to meet a VC fund’s exit deadline. The founders retained significant shareholdings and continued to run the business. The share price rose steadily over the following years as the revenue and margin picture became clear. Investors who bought early and held for three or four years made very substantial returns. The company’s patience in timing its listing, and its founders’ continued skin in the game, were signals worth reading.

Lock-up periods are one of the most important mechanics for public market investors to understand when a VC-backed company lists. When insiders, including venture capital funds, take a company public, they typically agree not to sell their shares for a defined period after listing, usually between six months and a year. This is designed to prevent early investors from immediately dumping shares onto the market and crashing the price. But when that lock-up period expires, the dynamic can change quickly. If a VC fund has been waiting to exit, and the lock-up lifts, a wave of selling can follow. The company may be performing well operationally. The share price can still fall. Watching the dates on which lock-ups expire is not a sophisticated analysis, but it is a useful piece of context that many retail investors overlook entirely.

The best VC-backed companies that have made the transition to public markets often had one thing in common: they were not in a hurry. They came to market when the business was genuinely ready, when revenues were recurring and growing, when the unit economics were proven rather than projected. Companies that list ahead of that point, under pressure from fund timelines or favourable market conditions, tend to leave public investors carrying the risk that private investors were paid to absorb.

None of this means that IPOs are always poor investments, or that VC-backed companies cannot deliver strong returns for public shareholders. It means that the context matters as much as the company itself. Asking why a company is listing now, who is selling and how much, what the lock-up structure looks like, and whether the founders remain invested after the float, will tell you more about the likely outcome than the growth projections in the prospectus.

The venture capital model is built around taking early risk and realising returns at exit. Public market investors who understand that model, and price it accordingly, are better placed than those who assume that VC backing is straightforwardly a signal of quality.

This post is drawn from The Little Book of Small-Caps by Cameron Oliver. Republished with permission.

Small Caps is a series drawn from first-hand experience of UK and global small-cap markets, updated as each new chapter arrives.

Disclaimer: The value of investments can go down as well as up, and you may get back less than you invest. This article is for informational and educational purposes only and does not constitute financial advice. Always do your own research and consider seeking independent advice before making any investment decision.

This article is for informational purposes only and does not constitute financial advice. Investment values can go down as well as up. Always do your own research before making any financial decisions.