Crossover investment, which combines both private venture capital and public market investment, is gaining popularity recently. It refers to the practice of investment firms investing in late-stage private companies right before their IPOs to capture the valuation spread between private and public markets. Crossover investors can benefit from sizeable returns and fast liquidity. This new approach is welcomed by GPs who want to extend their investment horizon and maximize returns. It also meets the liquidity needs of LPs. Though mainly adopted in biotech industry currently, crossover investment is expected to gain wider adoption given its advantages.
Crossover investment can bring considerable returns for investors in a short time
The main appeal of crossover investment is the high return it can generate quickly. Investors can invest in the pre-IPO round of a hot startup at relatively low valuations, and cash out soon after the IPO at much higher valuations. For example, a biotech company can increase in valuation from 1 billion USD pre-IPO to 5 billion USD after IPO. With the valuation spread, crossover investors can gain a large return in a very short period, sometimes in just weeks or months after investing. This is very attractive for funds looking for faster exits.
It extends investment horizons for GPs and complements early-stage funds
For GPs focused on early-stage investments, crossover funds allow them to retain ownership in star portfolio companies as they grow, instead of being diluted out in later funding rounds. They can invest more in follow-on rounds to maximize overall returns. It extends GPs’ investment horizons seamlessly without venturing into new unfamiliar growth-stage deals. It serves as a complement to early funds instead of an entirely new strategy.
It provides needed liquidity for LPs amid prolonged holding periods
Crossover funds can provide some liquidity relief for LPs facing increasingly long holding periods in private venture funds. With more companies staying private longer and funds taking 10+ years to unwind, LPs have been seeking liquidity options. Though small in scale, crossover funds offer faster distributions than traditional closed-end venture funds, thereby partially addressing LP liquidity needs.
Biotech is an ideal sector for crossover investments currently
Crossover investing is especially suitable for biotech companies which often stay private longer to meet regulatory milestones. Clinical-stage drug developers with proven technology can gain crossover funding ahead of IPOs. Investors benefit from short lockup periods to quickly capitalize on the valuation bump after public listing. Besides biotech, crossover strategy can also work for other capital-intensive sectors needing late-stage financing.
It may become more widely adopted by investors in the future
Considering the benefits, more venture investors and LPs are likely to embrace crossover investments. As companies stay private longer, late-stage private funding needs will persist, potentially fueled by crossover capital. However, some risks exist. Lower quality crossover deals may eventually lead to post-IPO stock collapses. And conflicts can arise if allocation between crossover and main funds are not properly defined. But overall, crossover investments seem poised for significant growth.
In summary, crossover investment provides a new approach to generate outsized returns quickly by investing in late private stage before IPOs. It extends investment horizons for early-stage funds while also addressing LP liquidity needs. Though currently more popular in biotech, it has potential for wider adoption across sectors.