That is a common misconception, but it's usually founders who are eager to sell, not VCs. There is a power law distribution of outcomes in startups. The big successes are so big that that's where all the returns are for investors.
VCs routinely reject startups because they worry that the founders are only interested in selling the company. We tell founders who are about to present to VCs never even to use the word "exit."
The VC model encourages/forces founders to go for huge exits. You can't do a series A round and then sell the company for 10 million. Probably not even 20. The VCs won't let you. So they're more likely to get the giant outcomes that make up for the losses on the rest of their portfolio. Whereas there's nothing to prevent the founders of a startup we fund selling early for comparatively little.
Also, VCs have leverage working for them. They get a percentage of the returns on other people's money. We're using only our own.
Smaller principal x lower returns = less profit. Probably. But we're hoping to make enough that we can at least keep doing this.
the only way to get a piece of the capital is by planning your exit strategy
VCs have always needed founders to have an exit in mind, but 20 years ago it just wasn't vocalised. There was never a time when VCs would put money in to a business that didn't have a clear way for them to get their money+profit out again. The dot.com bubble made everyone believe an IPO was the obvious way to cash out. When that bubble popped most founders started to see the exit as acquisition. That's all.
To be honest, the startup scene has changed a great deal over the past few years. When I did my first startup you could raise a seed round with nothing more than an idea; I got in to an accelerator before we'd even spoken to a potential customer let alone made an actual sale. Now you're unlikely to get very far with investors until you've proved the idea and got some significant traction. The level of risk people are willing to accept is really low. It's a shame, but it's quite understandable.
I think in part this is because the founders reach the point where they feel it's 'enough' way before VCs do, because VCs are risk hungry (distributing their risk across dozens of deals makes that easy) and want to roll the dice again and again. In the end, i believe that timeline of the VC's fund existence preclude them from meeting their return goals otherwise than through exits.
>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.
In addition, the exit must occur within the maturity term of the VC's fund.
I think he is suggesting VCs want much larger exits than the average founder (at higher risk). Isn't most of Y combinator's success from just a couple massive paydays (airbnb and dropbox etc)? Whereas an exit like reddit in the 15 - 20 MM range is considered a big win for the founders, but quite "meh" for the investors. VCs need big wins to be really successful.
Generally speaking, VC's aren't interested in getting their money back with revenues from the company they're funding. They aim for a 'big exit', in the form of an IPO or acquisition by another company.
Yep, but I couldn't care less about the portfolio, and the founders shouldn't either. You're pointing out why VCs need big exits, and even a profitable one like this one may not be profitable "enough", but that "enough" is their portfolio view.
From a founder view, we shouldn't be carrying the weight of the effective cost of the fact that the VCs can't pick companies worth a damn and want to make it up on us, if we happen to be good.
Nobody is entitled to venture capital, and starting a company without it is a good idea.
And VCs are not entitled to more equity & control than makes economic sense for the founders. That's what I'm opposing, but I don't think you disagree.
I think you need to look at this from Fred Wilson's perspective as a VC. Exit is the only the measure of success. It is how he and every VC is ultimately incentivized by their LPs. The more exits and the larger those exits, the more money the VC makes and the more likely they'll have LPs invest in their next fund.
Of course, one can argue that startups should be not be in it for the exit, but when you take VC money, that is what you are signing up for.
I don't know anything about this particular case, but it's very common for VCs to cash out at IPO or not long after. VCs identify and support early stage companies, they don't want to keep their money tied up in investments outside of their specialty.
The problem is that VC doesn't want to build a successful business, they want to build a profitable exit strategy. They want an IPO or acquisition that nets huge amounts of cash.
Diligently creating a business which turns a healthy profit for a fair exchange with the customer is less profitable than developing a large customer base that could be sold to someone.
Say what you will about the big players... there is no exit strategy. They are in the endgame.
Most VC's only make a decent return when at least one of their companies has a large (>$100m) exit. So VC's will generally be pushing their companies not to exit early, and to try riskier tactics to grow more.
No VC of any meaningful size is interested in a $50m exit.
Let's say as a VC you invested $3m and are holding 20% of the company at exit, that means you'll make $10m. A 3x return is nice but not going to be fund-maker.
If you're a $50m fund then you're expected to return >$150m, 10m will nudge you along to that target, but isn't going to be significant. Because a majority of your investments will go to zero or be small returners (1x-3x), it essentially means the good exits have to be >10x in order to be able to achieve reasonable returns for the fund.
I can't name companies specifically, but I know a few where VC-backed startups ended up buying out their VCs and bootstrapped their way to a modest success. The reasoning was simple: VC invested a Seed or Series A, 5 years later the company is breaking even and clearly won't return money to the investor, so the investor wants to cut their losses and stop "wasting" their time. VCs are on a fixed time horizon so they want to get out after 7-ish years.
One really cool case was the employees (rather than the founders!) actually put in a bid to buy the company and clean up the cap table.
These companies were big enough to merit the attention of their founders/employees but not the attention of VCs looking for a 50x return.
These situations are very rare, however. To your point about startup culture, if the culture itself is focused on bleeding money and growing to a unicorn at all costs, then I don't think anyone would want to go through the processes above.
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.
IF there's enough liquidation preferences, even a successful exit in the $50M range could leave nothing more than a fraction of your annual salary for everyone but the founders.
Every dollar taken in investment reduces the likelihood of regular employees cashing out unless it boosts the ultimate stock price and success chance of the company significantly.
Too much money is chasing too many companies so the founders are tempted to take the money, roll the dice and hope they become a Facebook, even though the odds of that are extremely slim.
This is the difference between a "startup" and a business. Startups used to be a phase of business, but it's become it's own thing now.
A business will not take money it doesn't have to, realizing that profitability will fund growth. (And to be honest, I don't see a lot of mechanisms by which VC money funds growth-- all of the successes hit a viral growth loop or opened a massive unmet need... the VC money just made product development easier... mostly after the tornado started.)
VCs routinely reject startups because they worry that the founders are only interested in selling the company. We tell founders who are about to present to VCs never even to use the word "exit."
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