Don’t worry about VC’s returns if you can exit your startup early
If you’ve been watching the recent wave of shows on disgraced startups (from Theranos to WeWork), you might be under the impression that startup founders have no sense of responsibility.
In my experience, however, the opposite is much more common: Entrepreneurs tend to feel guilty about things that are just part of startup life. For instance, many founders feel quite badly about merely admitting that they wouldn’t say “no” to a good enough acquisition offer, or telling their investors they’d do so.
Why does it matter if founders tell investors that they might take an exit before their company reaches IPO scale? I think the reasoning goes something like: “What’s good enough for me might not be good enough for my backers,” or a life-changing amount of cash for a founder might be too small an investment multiple for an investor.
And sometimes, these concerns is not just guilt rearing its head, but also the fear that VCs won’t let an acquisition go through if it happens too early in a startup’s lifecycle.
There are many reasons to stick it out at your startup, but if you’re worried about your investors when faced with an exit, here’s why you shouldn’t be.
Time is another element of VC math that founders don’t always consider — a 3x multiple in six months is not the same as a 3x multiple in three years.
In VC Land, 1 > 10
Letting people down is never pleasant, but that’s how it can feel to sell a startup early. Will investors be disappointed that your company never fulfilled its destiny? Well, yes, but only to a certain extent, and that’s where portfolio math comes into play.
Investors hedge their bets by making many investments, though they still hope that each of those bets pay off. However, they also know that it won’t happen. They’re in the game fully aware that that some of their investments will simply have to be written off, and a handful more will land somewhere in between success and outright failure.
But investing in startups still makes sense, because outliers will return their original investment value many times over.
In venture capital, big home runs have become a fixture. They have a name, too: “Fund makers,” and they signify an investment that generates more liquidity than the entire fund backing it.
In a 2014 post on TechCrunch, VCs John Backus and Hemant Bhardwaj coined a new term for these fund makers: “dragons.” They encouraged fellow investors to favor them over unicorns. “Unicorns are for show. Dragons are for dough,” they wrote.
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