] HipMojo.com » There is an Alternative Path to Liquidity, VCs just ignore it

There is an Alternative Path to Liquidity, VCs just ignore it

Fred Wilson asks a very good question:

So if you can’t take a company public, how do you get out? M&A has been the primary answer in the web/tech sector for the past eight years. And it’s been a great period to sell companies. We’ve sold three in the past couple years out of our Union Square Ventures portfolio, delicious, FeedBurner, and TACODA, to Yahoo!, Google, and AOL, respectively. Were we happy to take their money? Yes. Were we happy with the outcome? Yes. Were they good buys for their new owners? On the face of it, yes.

But if you look deeper, I wonder. Delicious grew nicely for a while under Yahoo!’s ownership but recently the user base has fallen off pretty dramatically. I double checked this chart in compete and alexa and they all show the dropoff.

Here’s what I think:

The major problem entrepreneurs face is knowing that the IPO market isn’t an option.  They also know that their companies aren’t necessarily IPO-worthy.  But because their companies operate in segments that have little barriers to entry and Google/Yahoo/Microsoft can always launch a competitor… so on the first semblance of an exit, they take it.

Do I blame them?  Yes and no.

An alternative would be for VCs to come along and give some liquidity to the founders to take some of the risk away and give them the appetite to continue to treck along.  VCs generally are against founder liquidity clauses - something I called the biggest mistake VCs and entrepreneurs make.  If VCs let more entrepreneurs take money off the table in subsequent Series B, C, D, E etc., rounds, they would be able to see beyond those initial M&A term sheets and go long.

Of course, this is a path to liquidity for entrepreneurs, not necessarily one for investors.  However, it’s easier to take a company from $10M to $100M than it is to take a company from $0 to $10M.  Ok, they’re both equally hard.  But the drive and determination to take a company from $10M to $100M is easier to come by when the entrepreneurs aren’t being distracted by a low-ball buyout offer.  And to do that, you need some liquidity for entrepreneurs.

In this content, if an entrepreneur has some of the risk removed, then it’s easier to use the subsequent funding to roll up some companies.

For example, imagine this scenario:

Delicious does not sell to Yahoo!, but instead raises $20M in funding and the founder gets $5M (for example).  But then Delicious uses $10M of that to buy or merge with Flickr.  In this scenario, Delicious and Flickr combine their respective expertise in tagging and image-sharing to develop a solution for videos… and presto: you have YouTube, basically… but with a deeper bench, diversified away from user-gen videos alone, etc.  I am not saying that Delicious + Flickr applied to video would be an IPO play… but if you start to add on bells, whistles, people, backers, etc., you can lay out a map to do just that.

This is a very quick and somewhat asinine example… but the point is: both Flickr and Delicious sold to Yahoo! (probably prematurely) but they could have easily gone on to bigger and better things had they remained independent or merged operations with other best-of-breed feature companies.

Just a thought.  I wonder what Fred would think.

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Posted By: Ashkan Karbasfrooshan | Apr 10th

4 Responses to “There is an Alternative Path to Liquidity, VCs just ignore it”

  1. fred wilson Says:
    April 10th, 2008 at 12:31 pm

    i agree

    fred

  2. Sebastian Says:
    April 10th, 2008 at 5:49 pm

    If you had actually read Fred Wilson’s article to the end, you’d have read the part that says that it’s not unusual that entrepreneurs sell pieces of their ownership to VCs.

  3. Ashkan Karbasfrooshan Says:
    April 10th, 2008 at 5:57 pm

    Sebastien, I did read it but I think the crux of Fred’s argument was a private equity exchange, and not founder’s liquidity.

    I do not think the private equity exchange is practical or realistic. Entrepreneurs and VCs don’t want to sell to random investors.

    It’s one thing to sell to the public in an IPO, but given standard shareholder agreements with piggyback and drag-along rights, to think that a private equity marketplace makes sense is not pragmatic in my humble opinion.

    However, if you have new investors coming in and buying out existing shareholders, that is a more direct transaction, I would think. Entrepreneurs and VCs are fickle with control and selling via a marketplace is pretty much a dream.

    I could be wrong, let’s face it, Fred has 20 years of experience over me, and more importantly, done this 100 or so times.

    I’m just talking from the entrepreneur’s perspective.

  4. nick Says:
    April 10th, 2008 at 6:29 pm

    interesting comments, but there’s more (as you know) to be concerned with than just the founder/entrepreneur. If there is some sort of liquidity, if it’s not shared with the employees in some meaningful way, you may lose many, either by leaving the firm or by resigning mentally. No entrepreneur wants that.

    Also, having just sold my firm to one of the “elephants” there are many things to consider. For some, it’s a validation of their vision, a sweet economic deal, and an opportunity to take that energy and move forward with a new start up.

    Holding out and taking on more capital is not without it’s own risks and raises the bar for an exit via M&A. The execution must be pin point, the industry must continue to grow, and economic cycles need to work in your favor (depending on what you sell and to whom). With all that, raising capital at the right valuation isn’t a given.

    Finally, the competitive threat is real. When the big guys decide to buy, they also evaluate build. If buy doesn’t work, then you have a whole new set of problems that may require a strategic shift and a whole new capital raise (see above).

    In the end, isn’t it a judgement on timing and value? Timing of all these things: markets, competition, investor readiness to sell, executive readiness to exit, ability to execute, etc… vis a vis price?

    Some firms will exit earlier if their timing, and that of their buyer is sooner rather than later. Others will have a longer runway and thus a greater time horizon for an exit. Either way I believe you build a firm with strategic, stand alone value, not to be sold to a particular firm, and if along the way that happens, you evaluate the price and time, and make an economic judgement, together with your board.

    Frankly, what the buyer does with the product/firm thereafter isn’t of concern to the entrepreneur (save an earn out of some kind). It’s just time to take on your next passion.

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