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Keep Wringing

My friend (and lawyer for Foley Hoag), Dave Broadwin, wrote today that he is optimistic, and we shouldn't be wringing our hands about how bad things are for startups.  He's got some evidence, some of which he got from me, that the pendulum has swung too far in lamenting how bad things are, particularly for venture capital-backed startups.

Well, the numbers that Dave cites from me are correct (9000+ venture backed startups in the US today and only 30 M&A exits in 2008 at prices of $150M or more).  I got these numbers from VentureSource.  They may not be perfect, but they should be pretty close.  There are many, many VC-backed companies in all different industries.  And, no surprise, the exit envionment is weak.

But, I'm not ready to stop wringing my hands.  Slowly but surely, the number of VC-backed companies will drop.  There are a small number of new companies being funded, and there is a greater number, I believe, in companies being sold or shutting down.  Only a small number of exits are 'successful' -- the investors make some decent money.  What's that, 2x or greater?  That's probably not enough to make the VCs or their investors happy.  But, doubling your money is a good starting point for successful investments.  There are also successful investments that sell for less than $150M if they haven't raised too much capital.

Quick VC math refresher:  If there are no recaps or wash out financings, here's how the math works.  If you assume that VCs own 75% of a company at the time it is sold, the company has to sell for 2.667x the invested capital for the investors to make 2x their money.  Now, that's a simplification as it doesn't take into account some VC terms that sweeten their outcome (dividends, participating preferred).  Also, it doesn't reflect that early investors may have a better multiple than later investors as they may have paid a lower price.  Or, later stage investors may make more than early investors if they add complicated structures to the deal.  In the end, each deal is structured differently.  But, If a company hasn't sold for at least 2.5x the invested capital, it's not successful.

There will be successful deals, and some very successful ones in this environment.  But, as a limited partner (LP) in a VC fund, you need the whole fund to be successful, after fees and carried interest paid to the general partners.  That requires a lot of successful exits, and some very successful ones.  I don't think that there are enough of those out there to keep LPs happy and to justify the fees that many GPs charge.  And, that has a lot of VCs and their LPs wringing their hands for the foreseeable future.


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