Why VCs Will Block Good Exits
A friend of mine founded a tech startup about five years ago. His investors were several prominent VCs. The company had an opportunity to be acquired by a much bigger company at a price that would have produced a return for the VCs of about 300% (i.e. 3x).
The management team was eager to sell because much bigger players were moving into their space and they had concluded that it would be much harder to win new contracts in the future. They also believed that because the big players were getting excited about their space, they would probably get the best valuation now.
But the VCs were Blocking the Sale
My friend couldn’t understand why his board was blocking the sale. He asked me why the VCs on his board couldn’t see the situation they were in and appreciate the opportunity for a great exit that was right in front of them.
I explained that it wasn’t the VCs who were missing something; it was my founder friend who didn’t get it.
This is not an isolated event. It happens all the time. I didn’t understand this until I had been a VC for a few years.
VCs will almost always block a sale where they only make a 3-4x return on their investment. This could have easily been a 10x return for the angels and a 100x return for the entrepreneurs.
The Math That Explains Why VCs Have to Swing for the Fences
This illustrates how VC funds have to ‘swing for the fences.’ The only way to make a VC fund perform is to invest and manage to increase the number of really high return investments.
The winners have to produce at least 10-30x return for the fund to perform respectably. This post shows the math behind VC funds and illustrates why the need this type of exit multiple.
Most Entrepreneurs Don't Know - I didn't
Most entrepreneurs don’t even know that a VC is likely to block a great return when they accept the VC’s money. I didn’t in my first company—and my friend didn’t either. For me, it wasn’t until the final extraordinary general meeting when the shareholders were voting to approve the exit transaction that I actually realized how aggressively a VC will try to block an exit.
Every Company Needs An Exit Strategy First - Workshop in Vancouver
This propensity to block exits is one of the reasons that every company needs a clear exit strategy before they approach their first investor.
If you would are interested in learned more about exit strategies, there is a brand new workshop on exit transactions for entrepreneurs and angel investors being hosted by the Vancouver Angel Forum on March 9. Information on this workshop is available here.
Although I chose to do things differently this time I have plenty of VC friends that I’d recommend to anyone interested in raising money. Contact me for any recommendations. Before you do that though I recommend you read “Why VCs Will Block Good Exits” carefully. Very simple math just make sure you do it before not after raising money.