VCball

Don't raise more money than you can chew

It's that time of decade. For the first time since 2000, it would appear that for companies with north of $50M or $100M in revenues, the IPO market is starting to heat up a bit. As most VC backed companies do not go public however, my partner, Brian, and I have found that watching the average acquisition prices be a bit more telling, as that's the typical exit for most companies.

A few weeks ago VentureWire reported that median average valuations for acquisitions of VC backed companies rose to $105M, 2X what they were a year ago. Last year the median acquisition price was $50M. It's been at this lower more typical level since the bust in 01 basically.

One of the things I've looked at is how much capital can a company raise and still make for a good return for investors-- but more importantly for entrepreneurs, as it's entrepreneurial drive and determination that create success. Demotivated founders and managers is the worst thing for a startup. If a founding entrepreneur raises $40M then exits at $50M then that's not a good result for anyone, after interest, dilution, closing costs, etc. An exit at $100M is better clearly, depending on how much dilution the $40M took. Here's the hitch: the average age of a company exiting ranges from 4 to 8 years depending on the market and segment (right now it's 6-7 years for IT companies I think).

Hence, an entrepreneur never knows if they will be exiting in a "good" $100M + market or a poorer $50M market. As an entrepreneur, you can pray that when the time comes to exit that you are in a bubble or an elevated 2X the standard merger and acquisition environment like we are in now, which always coincides with a decent IPO market. That window opens once every 6-8 years in my experience. But isn't it easier to just build a more capital efficient business that consumes less capital, than pray that 1/ not only do you deliver on the promise of your business but 2/ time the exit right?

Unfortunately, I've invested in 3 companies that cleared $25M in revenues with north of $50M in capital, only to get a goose egg (a "0") or near goose egg for everyone involved, so I talk from sad experience. There is nothing worse than building a great business, only to find out you consumed too much capital to make it rewarding for anyone. The lesson I took away was don't raise much more money relative to the experience of management putting it work on an efficient basis.

In other words, if your team has never handled more than a few million dollars, don't raise $25M without a bringing on team that's managed that type of capital efficiently. In addition, even if you could bring on such a team, I am still skeptical that they can break the average exit levels of $50M, as $25M is less likely to be used efficiently, even by capable managers, than smaller amounts. Bottom line is: don't put more money in your bank account than you can chew efficiently, as you will pay for it in the end, the exit.

Tear Off the Band-Aid

After reading Josh's surprisingly thought provoking post on American Idol he asks a rhetorical question which I think is at the heart of VC/Entrepreneur enmity: what feedback style should a VC have when discussing an opportunity with an entrepreneur?   

VC Feedback Style Options:

1/ Simon’s brutal honesty and candor (sometimes perceived as rude or ungracious)

2/ Paula’s unbridled enthusiasm and politeness (positive feedback only)

3/ Randy’s noncommittal, whats up dawg feedback (positive vibe only)

If left only those options, and can only pick one, I think great entrepreneurs prefer a Simon. 

Unfortunately, as Josh points out, being too direct without any praise, if done inconsiderately, can backfire on a VC and damage their reputation; I am sure I've bruised a few egos in my day.  Interestingly the Wall Street Journal "The Most Praised Generation" (sorry subscription required) had an interesting article discussing just this topic as well last Friday, regarding the possible sad need to give heavy stroking to a younger generation (those under 40, whom I count myself among), in order to retain their confidence and respect (who's group I don't count myself among).

I believe that great entrepreneurs will push back and thrive when challenged.  I find that the best entrepreneurs don't back down when the going gets tough, but redouble efforts and get more motivated.  They rise to challenges.  They don't blink in the face of a whithering assault.  And actually, from an investor perspective that's exactly what you want from a great entrepreneur, someone that doesn't require stroking and will rise to the challenges on their own, are justifiably self confident, aware of their weaknesses, and motivated.  Customers, potential managerial recruits, and alliance partners aren't going to give a startup any slack, so how can investor not test this sensitivity in some manner and still do a great job as an investor?

Sometimes it's tough getting that balance right between directness and mushiness in that first meeting; a VC or investor can rip that band-aid off too quickly.  I believe that this is possibly the heart of the bad rap that VCs often get from entrepreneurs, either by not giving enough feedback, or giving it in too harsh a form.  I work on it every day, hoping to strike the right balance, but if you have 200 meetings a year with tight time constraints, it's likely a few egos are going to get bruised.   That's part of the job of being a VC or entrepreneur. 

I am always looking for feedback, so I can do my job better, just like a good entrepreneur does.  So if you are an entrepreneur that I have met with, or even ended up backing, and haven't gotten that due feedback or feel like I was too harsh, be brave and do let me know.   Tear off that band-aid.

P.S.  I want to give credit for the "band-aid" analogy to David Lalich, a CEO that I recruited to replace myself from that role in a startup call AdOne (now merged with and called PowerOne).   I've used that metaphor for over a decade and it's served me well. Thanks David.