In the last year or so, venture capital investors have had to get increasingly creative to make money for their investors as startup exits have been few and far between.
The need for liquidity has led VCs to consider secondary sales (selling shares in portfolio companies to other VCs) and look at fund structures like continuation funds — which let VCs hold onto shares of companies after their traditional fund cycle of typically 10 plus two years draws to an end, while enabling their investors, LPs, to get some money back.
Recently, some VCs have also started tweaking funding round documents to give them more flexibility to sell startup stakes in the future.
Enter the portfolio sale clause
More investors have been trying to add a specific clause to funding round documents, dubbed unofficially a “portfolio sale clause”, venture lawyers tell Sifted. Simply put, this clause enables VCs to sell their shares in the company they’re investing in without giving other investors the right to block it or sell their own shares at the same time. This provision would only apply if the VCs were to liquidate their whole portfolio, not just the individual stake in that one company.
It’s been showing up more in the last two years, says Shing Lo, a VC and startups-focused partner at London law firm Latham & Watkins.
“We have seen of late investors asking for revisions in the long form documents which allows them to bypass preemption, co-sale and the like,” she says. In other words, right of first refusal and “tag along, drag along rights” — terms whereby an investor looking to sell shares in a company needs to first offer those up to other existing shareholders. Or, if they want to sell shares which would constitute a change of control, they have to allow other existing investors to sell their shares simultaneously.
This portfolio sale clause is typically used by funds that have been around for quite a while, and haven’t seen many exits — “so they need to be able to wind up the fund or sell some of the assets to another fund, perhaps,” says Lo. “[That] is why they've asked for the ability to have that kind of sale without triggering preemption or co-sale.” Lo says this clause would most commonly be introduced during a new funding round when documents need to be negotiated.
A fund might want more flexibility to liquidate stakes if they wanted to create a continuation fund, for example. Although continuation funds aren’t common in Europe, HV Capital became the first German firm to launch one in 2022, while Lo says she’s heard more funds beginning to talk about the option.
Lawyers say the portfolio sale clause is still rare in the startup world — but it could become more common.
Although she hasn't seen it used in relation to secondary sales, Lo says, “I wouldn't be surprised if this is starting to emerge as a thing that investors will ask for”, especially as VCs begin to engage in more secondaries.
Buying and selling stakes on the secondary market has become more popular in the last year or so to cash in on investments, and VCs have even been raising funds to capitalise on the trend. Lo’s colleague Mike Turner says secondary transactions have picked up — “every time we do a primary round now, there's the expectation that there's some secondary [shares being sold] in there,” he tells Sifted.
Bastian Reinschmidt, partner at German law firm Neon (formerly BMH), has observed the portfolio sale clause used to do more than just wind down an old fund. “It’s easy to say, ‘There's the end of the lifecycle for the fund and there's three investments remaining, and they just want to sell it,’” he says.
But he’s also seen it used by a VC that needed to close down a fund before its 10-year term was up, “for other reasons”. In this instance, which happened within the last two years, he says, the VC wanted to sell their portfolio to another investor.
A red flag for startups?
Deal terms have generally grown more investor-friendly in recent years as the downturn has made funding even harder to get (unless you’re an AI company). But is a “portfolio sale clause” a bad thing for founders?
According to Latham & Watkins’ Turner, it’s not a red flag. It could even be advantageous.
“If you do have an investor wanting an exit, because they've been in for such a long time needing liquidity, actually being able to clean up your cap table quite easily is a good thing,” Turner says.
However, Lo notes that if startups want to give investors this clause, they would probably want to ensure that the investor wouldn’t end up selling their shares to a fund that owns a direct competitor.
Reinschmidt, on the other hand, points out that the definition of a “portfolio sale clause” can be murky, depending on the actual wording in the contract. “The question is, what is the portfolio sale? Is it, you have 10 investments, and then they decide to liquidate three of them together? Is that a portfolio sale? … Or do you need to liquidate your entire portfolio?”
Beyond the ambiguity of language, it could also be a risk to allow one of your investors to include it. “If you open Pandora's box, and you give it to one investor, the others will also request it,” notes Reinschmidt.
For those reasons, he advises both parties — the founders and investors — to have an amicable negotiation over the terms. “It’s an understandable request from the investor side, so it's very important to have a smart negotiation style there,” he advises. However, he adds it’s key to “not make it too easy for them to call the clause.”
