VC Exits vs. Early Exits


Venture capitalists get lots of attention, and for good reason. Most of them possess an elite intelligence and pedigree combined with machete-sharp business acumen. The super rich trust them to find “the next big thing,” and they’re willing to pay VCs huge management fees to invest hundreds of millions of dollars on their behalf. It’s a great gig, and you only get it when you’ve proven yourself to the super rich or other VCs.

But the VC’s world is a world that only applies to a small minority of entrepreneurs, including successful ones. To use a baseball analogy, the VC is the home-run hitter that hits cleanup, and tries to blast the ball over the wall, but in the process, strikes out a lot. Just putting the ball in play and hitting for average doesn’t cut it, because to justify their business model, they need massive returns from at least a few of their investments. In fact, as one of my friends told me with respect to his brother who works for a VC, “these days, when his firm invests, they’re looking to hit a home run inside of a home run inside of another home run.”

When VCs invest a million dollars into a company, they’re not looking to make a 3-million or even a 5-million-dollar return on their investment. Rather, they’re looking for a 50-million-dollar or a 100-million-dollar return on their investment. To get the kind of returns VCs want to give their limited partners (usually in the neighborhood of 20% per year), VCs hope to have at least a couple of companies in their portfolio generating in excess of 30 times return on their investments.

This isn’t just an ideal. It’s an imperative. In fact, it is not uncommon for VCs, who, as part of their investment, receive board membership and control over the direction of the startup, to block a multi-million dollar sale of a startup company because the returns aren’t adequate for their approach to investing. While most businesses would think that doubling one’s money over a couple years is a tremendous success, the high-risk, high-reward nature of the venture capitalist doesn’t operate that way.

Basil Peters, author of Early Exits, estimates that 99.9% of merger & acquisition transactions take place at sale prices under $30 million. Because of this, most companies, even ones that have tremendous value and potential, hold little appeal to VCs. Conversely, most startups, and most entrepreneurs, are better off avoiding VC investment altogether.

This is a very controversial statement for a lawyer to make. And I am one of the only lawyers who works with startups that is willing to say it (because there is big money for lawyers in every VC deal), but I believe it to be true, and so I am going to say it anyway.

Most startups are better off avoiding the VC world altogether.

This is not to say that all startups should avoid VC money. If you think you are capable of creating a $100 million-plus business, and you’re right, then you’re in running, baby. But if your realistic expectations are or should be lower ($100 million is a lot of money), then you should look elsewhere.

If becoming a unicorn is your game, we can help you. But I hate to see startups pointing their vessel in the wrong direction from day one. I’d rather have a happy client that raises fewer rounds, but is ultimately successful, than see a client that is invariably going the wrong way.

As you’re starting out in this process, the first key to success for the entrepreneur is a little bit of self awareness.

Also, as you’re thinking through the projected trajectory for your business, know that sheer volume of money isn’t the only distinguishing factor separating an early exit from a larger one. Because of the need for high returns, the time from investment to sale has grown longer for the average VC-backed startup. According to Dow Jones Venture Source, between 1996 and 2001, the average time from VC financing to exit was less than four years. Today, that number is closer to ten years. Add in the fact that most startups are in existence for a few years before they receive VC investment, and you can see that most VC-backed companies can expect to wait awhile before an expected payday.

Most entrepreneurs I know would be very hesitant to sign on to a ten-year commitment to a startup. But that’s the reality of startup life today for a venture-backed company. It’s just that most entrepreneurs getting started don’t know it yet.

Just how big are the expectations from VCs today? Very big.

I look at Mint – $170 million exit. That is 10 percent of SolarWinds. I do not mean to cast aspersions on CubeTree or Mint or any of those. I am just saying that as a student of the economics of the tech business, to me, that is not where the action is. That is sort of a sideshow, where the main event is Facebook, Google, Twitter, Microsoft . . . . Some people will say, “Can’t you get excited about the $150-million exit?” I can make money on those deals, but I can’t get excited about them.

-Mike Maples, Jr. Managing Partner, FLOODGATE

None of this is meant to discourage anyone from seeking VC money if he or she thinks it’s right. For the very ambitious new growth company, for the truly revolutionary new product or platform, the venture capital route still makes sense. I represent a number of startups like this and I love working for them. I’ve had the good fortune to meet a number of VCs, and as a rule, they’re incredibly impressive. For most of the VCs I’ve met, they deserve the hype they get.

If you’re looking to grow like a rocket ship, and you likely need ten years to make your vision a reality, and you want the mentorship of an experienced venture capitalist helping you make decisions on your board, then venture capital is right for you.

But for the vast majority of businesses, even “growth” businesses, the early exit, lifestyle business, or life-long business approach makes more sense. And there is nothing wrong with simply having a successful business that earns you a good living! That’s what most people on earth dream of achieving. But the headlines of TechCrunch and VentureBeat sometimes make you think that raising capital is an absolute proxy for success. It is most assuredly not.

If you are looking for investors, angels or seed investors are usually thrilled to make a 2 to 5x return on an investment in a few years. And most entrepreneurs are thrilled to achieve an exit between $1 million and $30 million. While the venture-backed company often finds itself seeking more and larger rounds of funding to fuel its growth (these rounds are given alphabetical names to indicate their place in the order, such as Series A, Series B, and so on), companies that seek early exits tend to finance themselves with smaller “seed rounds” (typically for less than a million dollars) and then get out as soon as the right deal comes along. Or sometimes they just grow a profitable business.

Furthermore, most startup founders are not suited to helping a company grown to IPO. The characteristics that are required to take an early-stage startup from zero to a few million are very different from those required to take a mid-stage startup from a few million to over $30 million. Compliance with audited financial statements, significant board and investor pressure to meet quarterly revenue and growth expectations: it’s a very different world from the early days of first customers and unlimited expectations. Very commonly, VCs and boards will look to replace the initial CEO with someone better equipped to manage the early adolescent years of a startup.

Facebook and Twitter are five standard deviation events. It’s very uncommon for startups to immediately blow up and go viral where eight and nine-figure valuations come into play. Most often, a team of very smart and diligent entrepreneurs toils for years competing against equally talented and driven businesspeople in established companies and other startups.

Making big money is hard. Just as hitting a home run in the big leagues is a truly extraordinary accomplishment, only possible for the most talented athletes who dedicate themselves to their craft for years, so too is a successful VC exit a remarkable and pink-star-diamond-rare event. Heck (to continue with this baseball analogy perhaps one step too far), hitting a single or double in the major leagues is a near-impossibility for 99.9% of the world’s population. And so, too, is selling a business for in excess of a $1 million. An early exit – without the assistance of venture capital – is still an amazing accomplishment, and one that is much more realistic and potentially rewarding to the vast majority of entrepreneurs.

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