Startups aren't completely independent of the market. They either seek to IPO or be acquired by a company. Both of these possibilities are highly dependent on the availability of excess capital. When the market goes down, acquirers & potential IPO purchasers have less capital.
This doesn't mean it affects an entrepreneurs day-to-day life, nor should it. But, VCs by definition invest until they can get an exit. If the IPO and M&A market dries up, it is harder for them to get an exit, and thus they are less likely to invest.
In a down market, investors should be buying and not selling. In the context of VCs, it's probably a good time to fund ventures because the equity they get for their cash will be higher, and it's probably a bad time to exit because the cash they get for their equity will be lower. So, maybe VCs are simply being solid, patient investors.
Your private startup VC equity is not worth very much exactly when the stock market is doing poorly and you can't IPO or get acquired for BigCo stock. It seems very correlated to me.
It depends if the investor pulls their money out of the market when things start to shake down, or if they have some insights that would push them to do so ahead of a downturn. If they do, they might have _more_ money than usual to invest during a market downturn. Also, as a VC, your money is in a variety of startups that can crest even when the rest of the market goes sideways. Shopify had its IPO this year, others have been bought by the big guys, so their investors are now flush with new money. I mean if we have another big recession, there's going to be an investment chill so even an investor with cash to spare will have trouble finding partners to invest with. But we're not there yet.
The point is that because of the lower funding they have a lot more exit options than an average VC backed company and can exit in a lower valuation where an IPO doesn't make sense.
Of course some of your companies have awesome potential ( I wouldn't have applied if I didn't believe in the model) but they have a lower incentive to wait for an IPO than a VC backed company.
If a company's growth has dramatically slowed, but they are still profitable (even with a down year here or there), are VC's ok letting them chug along without an exit? My guess would be no and they'd push for some sort of private sale.
How does this help the VCs liquidate?; i.e. if the IPO market got killed in favor of such deals, wouldn't that discourage venture capitalists from making investments?
I'm sure there has been a discussion of this article before. But I get the feeling that you disagree with it's predictions. I'm interested to know which points you think are off & why.
The conclusion was that VCs are in a worse position. Investment needs to get smaller & to maintain their investment sizes VCs will need to buy shares from founders.
1 - Software Startups need/want less capital because of (a) lower technology costs (b) lower promotional costs (c) smaller teams.
2 - IPOs are less likely. This results in (a)the lower risk/reward goal of acquisition being set as a target. (b) less capital needed for the IPO process. I've added in point b
3 - Sellers' Market. (a)VCs' structure dictates investment size & fund size (as mentioned above) creating a surplus. (b)VCs are competing with acquirors offering a lower risk option. I imagine the current climate dampens these
I suppose the last point is most debatable. It may be temporary. The VC industry may contract or move away from Software. But if 1 & 2 are correct, this should result in smaller investments, founders cashing out or some combination of these. Do you see these points as being incorrect? Am I missing something else?
The thing with VC-backed companies is that many, and maybe most of them, are burning money and depend on raising fresh VC capital to stay afloat. If the VC spigot is turned off, all these companies will cut spending and/or fail at the same time. In a drought of fresh capital, the faster a VC-backed startup can reduce its dependence on other VC-backed startups, the greater its chances of survival.
I liked the article but the title is misleading. IPOs are drying up (no venture-backed company IPO'd in Q208), not capital itself. Money quote from the PWRC report cited by the article: VC firms are "raising funds at a steady pace."
So maybe this is more of a macro-economic or early-exit issue than a "VC is drying up" issue.
VCs need an exit to get a return. If not an IPO, then an acquisition. Unless of course the company becomes insanely profitable and can buy out their investors at a nice multiple.
Silicon Valley may be good at multiples, but not so good at profitability.
Acquisitions by private companies aren't as common as public companies, and the valuations aren't typically as high. So if everyone stays private, there aren't as many opportunities for 10x+ exits. Which means there's less cash to invest in high risk startups. VC's depend on the big winners to cover the countless losers.
If startups bootstrap, then they need to make money early. Which means you can't hire until you make money, but you can't make money unless you hire. So ambitions are seriously limited in the first couple of years. As are salaries. Not easy to attract great developers when you can't afford to pay them.
On the flip side, bootstrapping a company and focusing on building products that people not only love but are willing to pay for is insanely satisfying. There's also a lot of upside to working with a small team for many years before scaling.
Though I agree with you that it's important to stay positive and work to create rather than destroy, I share many people's concerns about potential misallocation of investment capital in tech startups right now, because the current model largely depends on it for it's continued sustainability. VCs need liquidity events in order to make a return, which are provided by going public, or by being acquired by companies that have already gone public and thus have large slush funds for acquisitions.
If that goes away, it could be a problem for the current model, because it's not designed to work for small success or failure mitigation. So if the stock market bottom falls out, it potentially takes down a lot of very promising startups that could have been successful and profitable with a different strategy. Their failures may not even be their fault, but simply bad market timing. This isn't a new thing, of course - it's been happening since the Panic of 1873. We're not exceptional to this risk, but I don't think we should ignore it.
You’d be entering the market at risk that the company you invested in:
a. Won’t be able to find follow on investors for its next rounds
b. Will be encountering customers that want to freeze or downsize their spend
That said, VCs raised a ton of money the last couple of years and eventually it has to get invested.
How many VC-backed startups were profitable before going public? Not many I can think of. Not any, really. That's why they push for growth instead of revenue or perish forbid, profits. It's easier then for the underwriter to create the pitch for potential investors. "Cash flow is negative but just look at those growth rates! Amazon made losses for 15 straight years,too yknow"
For VCs, the IPO is the end, not the means to an end.
They also argue that this poses a long-term potential problem for VC as well. Eventually an institutional investor wants their money back. Eventually they have to settle up and see who the Amazons are vs. the Pets.com. That forces businesses to transition towards exit in some fashion, if they move to IPO, this shift forces them to make a shift (to become profitable) which will kill some.
I don't see how that's a controversial point, but it's a distinction that a lot of people who aren't in tech, or around startups don't get.
This doesn't mean it affects an entrepreneurs day-to-day life, nor should it. But, VCs by definition invest until they can get an exit. If the IPO and M&A market dries up, it is harder for them to get an exit, and thus they are less likely to invest.
reply