 |
My first book: Early Exits is |
Sign up for the |
Subscribe to the |
 |
Venture Capital Exit Times
My two previous posts: Venture Capital Firms are Too Big and Venture Capital Funds - How the Math Works, described how venture capital investors will want to invest too much and exit only for very high returns.
Why are those bad things for entrepreneurs and angel investors?
Well, it turns out those can be extremely bad. These VC tenancies mean that:
1. Venture capital exit times are extremely long - much longer than you probably realize
2. The risks of actually achieving an exit decrease dramatically
This post describes why these factors make venture capital exit times so long.
Time Required to Generate 10x to 30x Returns
If the successful venture capital investments need to return 30x on average, or at the very least 10x, to generate a minimum VC fund return of 20% per year, how does that affect venture capital exit times?
The graph below shows venture capital exit times required to generate a minimally acceptable VC fund return from the winning investments.
Some companies will create increases in share value faster than 30 or 40% per year, but these are extremely rare. Everyone who has run a company knows that generating consistent 30 to 40% annual increases in value requires a great deal of hard work and some luck.
This is especially true when you realize that these are not just the increases in the overall enterprise value, but instead the increase in the value per share of the company. The difference of course is the additional dilution from any future financings or employee equity plans.
The 8 to 10 years shown in the graph above seems almost impossibly long. Could venture capital exit times really be that long?
The fascinating graph below shows actual venture capital exit times for US VCs. It shows that the median time from when a VC initially invested to an M&A transaction had been pretty stable in the late 1990s at around three years. The time to exit dipped to about two years in 2000. This was at the peak of the tech equity bubble when the velocity of transactions was incredibly high.
In the years since the tech bubble burst, venture capital exit times have steadily climbed to where they are now at seven years.
The practical implication of the data in this graph is more complicated than it appears on the surface.
What this Means for Entrepreneurs and Angels
To really understand how the decision to accept VC money will affect the founders, friends and family investors and angels, have another look at the graph above. Notice that graph shows that today the median venture capital exit time is seven years.
When you look quickly at the data, it might be tempting to think that the decision to add VC investors would add seven years to the time to exit, on average. A closer look shows that the real implications are quite different.
A Simple Model
The table below is a simple model to illustrate what is actual happening.
Most VC financings involve multiple VCs. As rounds progress from series A to B to C and the rounds get larger, the number of VC investors in each round tends to increase. There is a strong tendency for VCs in an earlier round to participate in the next round.
When does each type of investor actually invest?
The friends and family investors invest at startup, in year zero. The angels invest at year two (in this example).
The company progresses and decides to accept a VC series-A round in year four. Things go well and the company accepts subsequent series-B and -C rounds in years eight and ten. Things continue to go well and the VCs approve an exit that will give each of the VC investors the return they need in year sixteen.
What was the actual hold period for each investor type?
The first VC investment was in year four. So, the series-A VCs were invested for twelve years, the series-B VCs for eight years and the series-C VCs for six years.
There were two VCs in the series-A round, two new VCs in the series-B round and four new VCs in the series-C round.
This combination of VC investments totaled $25 million, the actual amount shown in the graph in the post Venture Capital Firms are Too Big.
So this model correctly illustrates median amount invested by VCs prior to an M&A exit. It also correctly shows the median time from investment to exit of seven years, the current time in graph above.
But, let’s look a little closer at What’s Happening to the Angels and Entrepreneurs
What this example shows is that the decision to accept VC investment increases the time to exit by approximately 12 years, not the median time of 7 years.
When VC investment was added to the corporate DNA, the time to exit increased to somewhere around sixteen years after the entrepreneurs started and twelve years after the angels invested.
This is, of course, just a model. There is no actual data available to prove this. But this model is a reasonably good approximation of what really happens to exit times when venture capitalists invest.
My next post will continue the exploration of venture capital exit times. This is also a main theme in my new book "Early Exits - Exit Strategies for Entrepreneurs and Angel Investors - But Maybe Not VCs."
