Sidecar Funds Investment Exit Strategies

Sidecar funds are a type of sidecar investment vehicle that allows investors to participate in investment opportunities alongside lead investors, such as angel groups or venture capital firms. The exit strategies for sidecar funds typically align with those of the lead investors, aiming to realize a return on sidecar investment through various means such as mergers and acquisitions, initial public offerings, or buyouts.

Investors in sidecar funds must be aware of the exit strategy as it affects the timing and potential returns of their sidecar investment. It’s important to have a clear understanding of the fund’s objectives and the exit scenarios that the fund managers consider favorable. This ensures that the investors’ expectations are aligned with the fund’s strategy and can lead to more successful outcomes.

Sidecar funding becomes quite a popular type of sidecar investment that suits passive investors. More and more people without experience in investing entrust the managing of investment process to professionals. At the same time, sidecar funding being profitable at the beginning of the investment can bring a dull result with wrong or the least suitable investment exit strategy. Merger and acquisition exit strategy is the most appropriate for the sidecar investment as it allows getting higher compensation due to future stock value increase. To confirm this thesis, all exit strategies should be considered, and the arguments in favor of merger and acquisition should be investigated.

General Theory of All Major Investment Exit Strategies

The life cycle of investment is typically less than 3-5 years. During this time, the company has to get stronger, demonstrating the ability to develop and return invested funds, thus ensuring a full refund to a funder with a certain share of profits (McKaskill 25). This return of capital is its direct exit, which performs with certain exit strategy.

The range of alternative exit strategies of venture investors from sidecar investment include the following options:

1. Merger & acquisition (M&A) – merger with a partner, acquisition by a competitor or other opportunities, the result of which should be a company the shares of which are worth more than the sum of the value of the shares of the original participants of the transaction.
2. An access to the stock exchange through initial public offering on the stock market (IPO) (McKaskill 37).
3. A purchase of shares of an investor by company’s management. In the international business practice it is called buy-back.
4. Cash cow creating exit strategy: in the case of a strong and stable cash flow from the start-up company.
5. A purchase of shares of an investor by employees of the company or team of outside managers.
6. Direct sale (trade sale) – sale of the investor’s shares to another investor.
7. The forced purchase of the shares by the company if the investor wants to perform an exit. It can be made if the value of the firm is lower than the assumed value in accordance with the business plan.
8. The forced exit through the control, the power of attorney or the liquidation of a company (McKaskill 34).

One can classify these exit strategies basing on the following characteristics inherent to the implementation of the chosen strategy: expected return, risk, financial costs, effort (difficulty and complexity of the process).

Return strategies funds of venture investors created through merger and acquisition or IPO are the most costly and are difficult to realize (M&A is less difficult than IPO); however, they may bring the highest profits comparing with other approaches. Nevertheless, choosing an exit strategy, sidecar investor must analyze a number of significant factors determining the advantages of a particular method. There are supporters and opponents of each of these strategies among the venture investors. However, the experience of recent years shows that, in foreign practice, quite often, preferred exit strategies are through the stock market (IPO), merger and acquisition and trade sale. This is mainly due to the fact that the sale of the shares of business to a large number of investors can be more profitable than the sale to one or more strategic partner to become co-owners.

The introduced range of alternative exit strategies includes both aspirational and negative versions, which, however, can take place during exit. However, in the case of sidecar funding, there is one strategy, which is the best.

What Are The Risks of Investing in Sidecar Funds?

When considering the landscape of sidecar investment opportunities, sidecar funds stand out for their unique partnership structure. These investment vehicles are designed to accompany lead investors into promising ventures, offering a distinct approach to capital allocation. However, like any investment strategy, sidecar funds come with inherent risks that must be carefully evaluated. Below is an overview of the key considerations associated with sidecar fund investments, highlighting the potential challenges and areas of caution for investors. Each point underscores the importance of due diligence and strategic planning when engaging with sidecar investments.

Investing in sidecar funds involves several risks, including:

Losses	Sidecar funds may lead to significant losses if the lead investor’s portfolio underperforms.
Liquidity	Sidecar fund investors often face challenges due to the lack of liquidity, making it difficult to withdraw their investment when needed.
Dependence	The success of a sidecar investment is closely tied to the lead investor’s expertise and performance.
Market Risks	The sidecar fund is exposed to market risks that can affect the overall sidecar investment climate, including economic downturns.
Control	Investors in sidecar funds are limited control over the investment decisions, which are managed by the lead investor.
Diversification	Sidecar funds are sometimes less diversified, which can increase risk if there’s a heavy concentration in a particular sector or company.

It’s important for potential investors to thoroughly understand these risks and consult with a financial advisor before committing capital to a sidecar fund. The specific risks associated with a particular sidecar fund will depend on its structure, the lead investor’s strategy, and the underlying sidecar investments.

Merger & Acquisition Exit Strategy as the Best for Sidecar Investment

Sidecar funding implies trust sidecar investment. This means that a passive investor, who gave to another person the opportunity to invest, can realize exit with the help of all the strategies above (Hall and Courtland 28). However, mergers and acquisition will be the best option. The passive investor does not perform time choice, type, and direction of investment (Payne 2). He/she does not participate in the management of these processes, having a lower return on capital. Sidecar investor renders the risks, so benefits that he/she receives during the business development to a large extent depend not to him/her. Thus, mergers and acquisition strategy can compensate it with the exit. This compensation is due to a certain kind of cashing of his/her future transaction. At the same time, on the one hand, investors can make the exit in accordance with the sidecar fund’s number of shares and their value on the sale date. This means, according to New Brunswick Securities Commission, that they will receive their portion of the total sales proceeds received by the sidecar fund. On the other hand, investors can exit in accordance with the sidecar fund’s number of shares and their value on the sale date, the sidecar fund will receive its portion of the total (New Brunswick Securities Commission 12). In this instance, the money from the sale remains in the sidecar fund and is re-invested in future deals. This will make it so that the fund will be self-investing (New Brunswick Securities Commission 12). Moreover, in the process of preparation to exit through mergers and acquisition, іnvestor receives preliminary benefits.

Horizontal merger can be made in the same industry among companies. This initially results in some economies, such as reduced overlapping positions, and the production capacity will be better utilized. Thus, the efficiency of the combined company is higher than the total efficiency of the firms before the merger. The savings will increase the corporation’s profits, and, most importantly for shareholders, will increase shareholder value. This horizontal merger has sense; both companies get benefit – reduced costs and increased profits. From the side of merger participant, it is easier to buy existing firm than to build a new one. The market valuation of the property complex of the target company is significantly lower than the cost of replacing its assets. From the side of sidecar investor, benefits are also obvious as he/she receives a better return on invested capital at the exit compensating own passivity during the process of investment by a profitable exit.

Vertical merger or acquisition takes place if the sidecar fund exits by a way of merger of companies of the same industry but different processes. As a result, the effectiveness of the new firm will grow as the same corporation will control all production. This ensures the success of the new company and its stock price will only increase. In this case, the sidecar funder will receive similar compensation as the expected growth of shares will increase the exit compensation.

The merger of different sectors causes the formation of a conglomerate. For example, the steel company buys banking business. Such association is able to diversify risks of steel firm since if demand for the metal falls, demand for banking services will not be affected. The company will be able to receive cash flow from its banking business. In this case, increase in cash flow is expected firstly, and then the share price will rise which is also beneficial for sidecar funder.

Thus, if investor uses a merger or acquisition, he/she will expect the growth in stocks due to a reduction in operating costs, greater purchase ability, tax benefits (especially if one of the companies has such a resource), lower interest rates for taking loans (for example, one firm has a good credit history), stronger trademark (one company has paid great attention to the development of the brand), the creation of a full cycle of production and sale of goods or services that will reduce costs and increase the speed of turnover of manufactured goods (gasoline can be sold faster and cheaper on the own gas station than on those belonging to other people).

The strategy of mergers and acquisitions is risky, but it allows to increase significantly the share of the company on existing market segments as well as to expand into new markets. The approach enables the fastest growth and strengthening of the competitive position by entering new regions, it allows to increase a firm’s list of services and number of clients. With skillful organization of the process of M&A, the company achieves synergies by combining experience, knowledge, technologies, personnel and resources.

Thus, the main reason for the use of M&A as an exit strategy is the increase of the exit benefit of sidecar investor due to the expected growth of shares value and cash flow from the emergence of synergies. Initial investor is passive during the process of funding (Rosenblum 3). However, he/she will receive more compensation as a result of the interest of owners of the merged businesses in future synergies.

Conclusion

Thus, sidecar funding becomes a popular passive kind of sidecar investment. Funders apply various exit strategies such as merger and acquisition, initial public offering, repurchase of shares by company’s management, cash cow exit strategy, direct sales (trade sale), forced exit and others. However, merger and acquisition allows increasing the compensation fund due to expectations of rise of the value of shares and an increase in cash flow, which makes fund self-investing. Thus, mergers and acquisition exit strategy is the most appropriate for the sidecar investment, as it allows getting higher compensation due to future stock value increase caused by synergy effect, which confirms the thesis put forward.

In conclusion, the rise of sidecar funding reflects a growing trend towards passive investment strategies that allow individuals to participate in venture opportunities with less active management. This form of sidecar investment has garnered attention for its potential to yield significant returns while aligning with seasoned investors’ expertise. As sidecar funds become a more prevalent choice for those looking to diversify their portfolios, it’s crucial to acknowledge the risks and conduct thorough research. Ultimately, sidecar funding represents a compelling avenue for passive investors, provided they navigate the investment landscape with prudence and informed decision-making.

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