Great post, Ryan. I read it a couple of times and really enjoyed the content!
A few questions:
1. For Buckets 2 & 3, have you seen VCs and founders negotiate a win-win wind down? So that the company is sold, and the VC chooses not to take their entire 1x liquidation preference, to incentivize the founding team to go along with the sale? It seems to be more of a win-win in an unfavourable scenario, than going to zero. I've read that some VCs will do that, especially for founders whom they believe in, partially to preserve the relationship to invest in their next start-up. Have you seen this in action?
2. Again for Buckets 2 & 3 companies that should be sold, wouldn't VCs have board control by Series B to push through a sale?
3. For Seed/Series A investors that look for fund-returners, wouldn't a lot of point solutions with solid initial traction fall into Buckets 2 & 3 and become uninvestable? They either can't cross the chasm to continue their growth rate or become strategic acquisition targets of a platform company if they achieve solid growth.
PS: The Fred Wilson blog was an interesting read! He was arguing even back in 2007 that capital efficiency is key, especially as a start-up is experimenting what business model works, and that you should only scale when you've found a model that works.
1. VC's have a fiduciary responsibility to protect their LP's capital, so no, I don't think I've ever heard of a VC waiving their liquidation preference. What I have seen, however, is VC's negotiating a management bonus / payout for getting a sale done (not a wind down), to incentivize getting at least some capital back (versus zero). On the point about preserving relationships with Founders, I think generally they understand the game they're playing and know that a VC has to respect the Liq Pref. In my experience, I think Founders are moreso looking for professionalism and honesty from their VC's when the business doesn't work out
2. There are two points here: one, VC's typically don't have Board Control (even by those stages), and even if they did, they tend not to be in the business of forcing anything on Founders (or they risk reputational damage). I also think many of these businesses end up in the scenario in which you outlined in your first question, where any sale price they could get is now far below the liq pref stack
3. Correct. Many, many companies at Seed in particularly never go on to raise another round or sell. I think I've read that something like 80% of Seed companies fail, so you're correct
Maybe another reason for the power law would be the nature of exits for VC investments? In light of the fact that most exit routes are by way of IPOs and only a small percentage of Seed ~ Series A companies will go IPO, it's either a large return from IPO or no return at all.
Love your article, but just wanted to know your thoughts on this.
Good question! Based on my understanding (and from the data I'm able to pull from Pitchbook & Crunchbase), I think there are actually far more Sales than IPO exits for startup companies. Crunchbase claims that of startups that do exits, Acquisitions outnumber IPO's 10:1 (https://news.crunchbase.com/liquidity/seed-funding-series-a-success/)
These range in magnitude from i) massive strategic sales (e.g., Google acquires for $X billion); ii) targeted strategic sales / tuck-ins; iii) Financial Sponsor / private equity acquisitions; and iv) acqui-hires. I think ii) and iii) here would represent the "missing middle" I alluded to in the article, because (as you alluded to), these businesses are too small to go public)
Great post, Ryan. I read it a couple of times and really enjoyed the content!
A few questions:
1. For Buckets 2 & 3, have you seen VCs and founders negotiate a win-win wind down? So that the company is sold, and the VC chooses not to take their entire 1x liquidation preference, to incentivize the founding team to go along with the sale? It seems to be more of a win-win in an unfavourable scenario, than going to zero. I've read that some VCs will do that, especially for founders whom they believe in, partially to preserve the relationship to invest in their next start-up. Have you seen this in action?
2. Again for Buckets 2 & 3 companies that should be sold, wouldn't VCs have board control by Series B to push through a sale?
3. For Seed/Series A investors that look for fund-returners, wouldn't a lot of point solutions with solid initial traction fall into Buckets 2 & 3 and become uninvestable? They either can't cross the chasm to continue their growth rate or become strategic acquisition targets of a platform company if they achieve solid growth.
PS: The Fred Wilson blog was an interesting read! He was arguing even back in 2007 that capital efficiency is key, especially as a start-up is experimenting what business model works, and that you should only scale when you've found a model that works.
Thanks for reading, Kevin. A few thoughts:
1. VC's have a fiduciary responsibility to protect their LP's capital, so no, I don't think I've ever heard of a VC waiving their liquidation preference. What I have seen, however, is VC's negotiating a management bonus / payout for getting a sale done (not a wind down), to incentivize getting at least some capital back (versus zero). On the point about preserving relationships with Founders, I think generally they understand the game they're playing and know that a VC has to respect the Liq Pref. In my experience, I think Founders are moreso looking for professionalism and honesty from their VC's when the business doesn't work out
2. There are two points here: one, VC's typically don't have Board Control (even by those stages), and even if they did, they tend not to be in the business of forcing anything on Founders (or they risk reputational damage). I also think many of these businesses end up in the scenario in which you outlined in your first question, where any sale price they could get is now far below the liq pref stack
3. Correct. Many, many companies at Seed in particularly never go on to raise another round or sell. I think I've read that something like 80% of Seed companies fail, so you're correct
Thanks for the quick response, Ryan. I really enjoy the content so far and look forward to reading more weekly posts from you!
Thank you! Always appreciate the feedback
Maybe another reason for the power law would be the nature of exits for VC investments? In light of the fact that most exit routes are by way of IPOs and only a small percentage of Seed ~ Series A companies will go IPO, it's either a large return from IPO or no return at all.
Love your article, but just wanted to know your thoughts on this.
Good question! Based on my understanding (and from the data I'm able to pull from Pitchbook & Crunchbase), I think there are actually far more Sales than IPO exits for startup companies. Crunchbase claims that of startups that do exits, Acquisitions outnumber IPO's 10:1 (https://news.crunchbase.com/liquidity/seed-funding-series-a-success/)
These range in magnitude from i) massive strategic sales (e.g., Google acquires for $X billion); ii) targeted strategic sales / tuck-ins; iii) Financial Sponsor / private equity acquisitions; and iv) acqui-hires. I think ii) and iii) here would represent the "missing middle" I alluded to in the article, because (as you alluded to), these businesses are too small to go public)
This is a fantastic post Ryan, would definitely be back to re-digest this!
Great article, at the end of the days, for entrepreneurs who are there to make it:
-Get a strategy and business as sound as possible
-Execute in speed and get product-market fit
-Raise the money at a reasonable valuation
-Spend well and allocate the resource to the right places
-Balance growth with unit economics profitability