The new paradigm for V.C. Investing
The new paradigm for V.C. Investing
The most likely lifecycle for start-ups in order of likelihood:
(1) bankruptcy (far and away the usual exit),
(2) merger with another loser which prolongs the agony for all,
(3) sale,
(4) IPO (rare), and
(5) staying private forever.
in the mid 1990s IPO became the overwhelming focus where M&A used to be a much more important and likely exit for venture capital. At the same time pre-money valuations soared to new stratospheres. Remember when the term “sweat equity” had meaning? Like “I have toiled in this business with low or no pay to bring to the point where it is worthy of investment.” Instead of simply “I came up with an idea?”
The model of the 1990s and since is clearly dead. There will be those who resist the change, as evidenced by the current exuberance of the renewable energy investors, but soon enough reality will set it.
Their seems to be confusion between the Seed/Startup stage and the VC Stage.
• Seed/Startup stage provides initial funding and a lot of hand-holding and oversight. Example - there are construction loans and there are home mortgages - both serve the same Industry but each is completely distinct.
• The Venture Capital stage provides additional money for growth, introductions for business development/partnerships and team building assistance. The VC stage does not nurture as much as perform triage and identify the winners.
Once a company has achieved a level of traction (revenue, customer base, number of visitors, validation partners, etc.) then a Venture Capitalist will step in and provide Venture Capital stage assistance. One of the other reasons the smaller deals got more difficult to do was that as mutual and other investment funds got bigger, the small companies became impossible to invest in for the larger funds.
Companies successful in the Seed/Startup stage can flow into the Venture Capital stage. What model will work going forward? Smaller funds, more reasonable GP comp, smaller investments, lower pre-money valuations, focus on profitbality, and M&A as the exit.
The idea of a non-revenue company finding VC interest in the future with no foreseeable form of revenues in their future might be a candidate for an early acquisition vs. finding a white knight.
It seems possible that we actually might see a return of some smaller companies going public, on the other end of this economic crisis.
• Financial assets are only worth the present value of future cash flows.
• The value of every financial asset to its equity owners is the present value of free cash flow.
The problem with money chasing deals is that companies become over capitalized and can never catch up to value expectations. Venture capital doesn’t have a good track record in early stage. This does not work economically and it does not work operationally. The large firm early stage venture capital model is broken irreparably. The good news is that entrepreneurs have figured this out and are being much more efficient in their use of cash and finding different ways to advance the ball. It’s the VC industry that hasn’t adjusted, because it’s an industry that now depends upon getting large amounts of money under management, rather than having a fund size that is appropriate for the new realities of early stage venture investing.
It wouldn’t be surprising to see a few new small banks spring up in response to the demise of so many of the larger firms, some smaller funds being started and high growth companies looking to the public markets for capital again.
The cost of going public must come down, industry expectations of exorbitant returns must be adjusted, and Managed Funds must downsize. Returning to the times of less money invested in smaller and more cash efficient start-ups — makes some sense.
The paradigm has changed for the venture business. We can no longer realistically expect the same kinds of absolute returns that were achieved in the past through a quick turnaround from start-up to liquidity through an I.P.O. Rather, most of the companies that venture capitalists are funding today will find an exit through merger or acquisition.
The new paradigm for VC Investing - To learn more about this author, visit Carl Moore's Website.
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Venture Capitalists and Private Equity firms alike insist that they only way to garner return on investment is to exit. If you’re investing in businesses that have real revenues and are, or soon will be, profitable and cash flow positive, why don’t you hold the company in a portfolio and take returns in the form of annual dividends? Depending on an exit for a return on your investment seems the highest risk kind of investment of all.
The most likely lifecycle for start-ups in order of likelihood:
(1) bankruptcy (far and away the usual exit),
(2) merger with another loser which prolongs the agony for all,
(3) sale,
(4) IPO (rare), and
(5) staying private forever.
in the mid 1990s IPO became the overwhelming focus where M&A used to be a much more important and likely exit for venture capital. At the same time pre-money valuations soared to new stratospheres. Remember when the term “sweat equity” had meaning? Like “I have toiled in this business with low or no pay to bring to the point where it is worthy of investment.” Instead of simply “I came up with an idea?”
The model of the 1990s and since is clearly dead. There will be those who resist the change, as evidenced by the current exuberance of the renewable energy investors, but soon enough reality will set it.
Their seems to be confusion between the Seed/Startup stage and the VC Stage.
• Seed/Startup stage provides initial funding and a lot of hand-holding and oversight. Example - there are construction loans and there are home mortgages - both serve the same Industry but each is completely distinct.
• The Venture Capital stage provides additional money for growth, introductions for business development/partnerships and team building assistance. The VC stage does not nurture as much as perform triage and identify the winners.
Once a company has achieved a level of traction (revenue, customer base, number of visitors, validation partners, etc.) then a Venture Capitalist will step in and provide Venture Capital stage assistance. One of the other reasons the smaller deals got more difficult to do was that as mutual and other investment funds got bigger, the small companies became impossible to invest in for the larger funds.
Companies successful in the Seed/Startup stage can flow into the Venture Capital stage. What model will work going forward? Smaller funds, more reasonable GP comp, smaller investments, lower pre-money valuations, focus on profitbality, and M&A as the exit.
The idea of a non-revenue company finding VC interest in the future with no foreseeable form of revenues in their future might be a candidate for an early acquisition vs. finding a white knight.
It seems possible that we actually might see a return of some smaller companies going public, on the other end of this economic crisis.
• Financial assets are only worth the present value of future cash flows.
• The value of every financial asset to its equity owners is the present value of free cash flow.
The problem with money chasing deals is that companies become over capitalized and can never catch up to value expectations. Venture capital doesn’t have a good track record in early stage. This does not work economically and it does not work operationally. The large firm early stage venture capital model is broken irreparably. The good news is that entrepreneurs have figured this out and are being much more efficient in their use of cash and finding different ways to advance the ball. It’s the VC industry that hasn’t adjusted, because it’s an industry that now depends upon getting large amounts of money under management, rather than having a fund size that is appropriate for the new realities of early stage venture investing.
It wouldn’t be surprising to see a few new small banks spring up in response to the demise of so many of the larger firms, some smaller funds being started and high growth companies looking to the public markets for capital again.
The cost of going public must come down, industry expectations of exorbitant returns must be adjusted, and Managed Funds must downsize. Returning to the times of less money invested in smaller and more cash efficient start-ups — makes some sense.
The paradigm has changed for the venture business. We can no longer realistically expect the same kinds of absolute returns that were achieved in the past through a quick turnaround from start-up to liquidity through an I.P.O. Rather, most of the companies that venture capitalists are funding today will find an exit through merger or acquisition.
The new paradigm for VC Investing - To learn more about this author, visit Carl Moore's Website.
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