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Finding the Exit

Fred Wilson wrote this morning about finding a "new path to liquidity" for start-ups.  He is fundamentally conflicted between being a VC and being a user of web services.

As a VC, Fred makes his money by either taking his companies public (harder and harder to do, particularly in the Internet sector) or by selling the company to some sort of acquirer who can pay cash or liquid securities.  Fred needs this liquidity to deliver a return to his investors.  By all accounts, he has done a great job at this.

But, since the IPO market is very tight, most companies get sold.  And, most acquirers don't realize the initial vision that the start-up had for its service.  Maybe they just want the technology and not really the product or service.  Maybe they lose focus and move onto the next corporate priority.  Or, perhaps they just can't execute well because of their size.  This doesn't always happen, but Fred reveals his frustration as a user of services that have been bought, and sub-optimized, by big acquirers.

Fred also mentions some new liquidy options for private companies, Goldman Sachs's GS True Market and Opus-5.  While I don't have any direct experience with these, the idea is that these are marketplaces where private company stock can be bought and sold between qualified investors.  Private equity firms can buy start-up positions from VCs, for example.

This type of exit can provide some liquidity and get a VC out of a position that they no longer want to hold.  But, I am skeptical that it will provide the high-multiple returns that VCs need to deliver the results that their investors expect.  Private equity firms like to value companies based on cash flow.  Most private companies that can't go public or be sold at a nice price to a strategic buyer probably don't have financials that will support a high exit price.  So, this may be liquidity, but it isn't a substitute exit that VCs really need.

And, the private equity buyers may allow the stand-alone services to grow on their own longer, perhaps realizing the vision that Fred the user is looking for.  But, if the company can't generate sufficient cash, it will go by the wayside.

On a cynical note, one point that Fred missed is that he needs the big strategic buyers to sub-optimize their acquisitions.  That creates gaps in the market that become opportunities for the next wave of start-ups to capitalize on.  If the big companies did a great job, then start-ups wouldn't thrive.  An example might be Cisco.  Although far from perfect, they did such a good job in the enterprise router market that there just wasn't much business left for anyone else.  Now, start-ups really struggle in that space and only a few get funded.  If Cisco screwed it up, there would be plenty of opportunity.

In the end, the only real exits that deliver VC returns are ones where the hype exceeds the reality, at least temporarily.  This would either be a nicely priced IPO, where the price is baking in a lot of future growth, or a sale to a strategic buyer who is willing to pay much more than what the financial statement justifies on its own.


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I have no idea how to keep management interested in staying in place for the long-term, and from the view of a complete outsider, it seems impossible. I always thought that innovation only arose out of disruption.

As far as the VC returns, that is a problem of investor expectations and the current business model. Just sell a different result when you raise the fund. Of course, that's easy for me to say. Fred, I assume that with your own money you will still have some expected level of return?

In Fred's comments someone suggested debt recaps. We've seen the PE funds do dividend recaps over the past few years, and much to my surprise the market has tolerated them well. Debt funding is difficult for these types of companies, but as they turn the corner to profitability, I would think that debt would be at least theoretically possible. Now we just need someone to fill that market niche. Sadly I don't see that happening anytime soon.



you are right about all of this.

someday, i want to invest my own money, not those of others, because then i might be able to reconcile the tension between being an investor and a user.

as an investor, i have a responsibility to generate the highest returns for me and my investors

but increasingly i find myself torn by that requirement


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