About VC financing
While sitting in my “Private Equity – Venture Capital” class last week at London Business School, I had a couple of thoughts about Broceliand that I want to share with you guys. I hope this will complement the excellent, and very up to date, document that Julien wrote about this subject (see –Les ecrits – Ecosysteme et Finance) :
- Respect the VC hierarchy : Academic research shows consistency among VC performance (i.e from fund to fund, the best performing VCs remain the best and the worst remain the worst). For that reason, everybody wants to get the winners (investors and entrepreneurs). When you are an entrepreneur, getting to the top of the VCs pyramid is key not only for establishing credibility, but also because you keep your options for later rounds: While any VC would consider investing in a company backed in first round by Accel or Kleiner Perkins, few people would follow an unknown or mediocre VC.
- Understand the rules of the game : As Julien explains very well, VCs seek primarily financial return, but also care about the mutual understanding they have with the entrepreneurs and early investors. The new equity VCs bring will dilute substantially the previous investors. Some investors do not understand this mechanism and refuse the VC conditions (and money), therefore they prevent the company from accessing to funds required for its growth. They are referred to as Dark Angels.
- Exit, exit, exit…but with IPO : VCs are obsessed by the exit, and the best exit scenario for them is IPO because it usually provides a higher valuation than a trade sale.
Filed under: Finance by Karim Ayari on September 18th, 2008
Cool! IPO is indeed our only exit scenario.
Thanks Karim!
Very interesting, I thought IPO were not that efficient as to VC since they are more time consuming and resourcefull than simple sales. Could you explain it to me ?
Thanks Karim! The first point could be very important in our next round. “Insha’Allah”
About the exit strategy, like everything in finance, the right answer is “it depends”…(on the maturity of the company, the timing, the industry, …)
In terms of valuation, the differential is due the liquidity discount trade buyer will account for (25-30%). This could be offset by the synergies buyers hope to realize in case they are substantial.
However, for an IPO to be the right strategy you need to crate enough appetite within the public markets to support not just the primary offering, but also the secondary market. The market has to understand what is going on if you will be cash negative for instance.
On the other hand, if you can flip it around quickly to a trade buyer, it is safer, then it is a reasonable issue.
In reality, around 35% of exits are done via IPO and around 50% via TS (the rest are other routs such as liquidation) but here is a quote form a VC on this matter :
..”if you presume that all of your companies will go to IPO, you are being very naïve. I believe our default strategy must be a trade sale. An IPO opportunity is a bonus”
…