The Tug Of War Between M&A and VC

Entrepreneurs and the companies they create are the raw material of the startup world. There has been an ongoing tug of war for their hearts and minds between big companies and VCs.

For a while the big companies were winning. From the internet bubble burst until recently, most every hot company to come out of the Internet startup scene was acquired or at least seriously considered being acquired by a big company. Skype is the iconic transaction. Yahoo!'s failed bid for Facebook also comes to mind. But it appears that VCs are making a strong comeback led by newly energized later stage investors and even some hedge funds.

The innovator in this trend is a russian investment firm called DST, which did a $200mm financing for Facebook last May. That financing was a combination of primary (money went into the company) and secondary (money went to buy shares from employees and existing shareholders). Since then DST has also done a similar transaction in our portfolio company Zynga.

But there's something new going on that bears mentioning. VCs are starting to compete directly with the M&A market. 

Last winter, when word broke that our portfolio company Twitter had rebuffed a $500mm acquisition offer from Facebook, I received several calls from late stage VCs who essentially said "well if that didn't work for you, how about an investment'? I introduced those VCs to Twitter who did two rounds of financing in 2009.

And now comes word that Elevation Partners is doing a $50mm round (primary and secondary) in Yelp in the wake of Yelp's rebuff of the Google purchase offer. Apparently these kinds of deals are being called "DST deals". Silicon Valley is all about recognizing a good idea and running with it. And I expect we'll see a lot more "DST deals" coming.

I was discussing this trend with the CFO of a large public company last friday morning. He asked the right question, "will DST and the others make a good return doing this"? I told him we'll know in three to five years.

The reason that is such a good question is it gets to the sustainability of this model. M&A is and will always be a sustainable exit model for entrepreneurs and VCs because big companies are always in need of new products and technologies and don't always need to be able to extract a cash flow stream from their acquisitions.

But companies like Facebook, Zynga, Twitter, Yelp, etc, etc will need to go on to become large profitable public companies in order to justify these financings. 

Of course, it is possible that these late stage deals are simply prolonging the time before these companies are bought. That would be the natural outcome if any one of these companies concludes the "go it alone" strategy is not going to work. In that scenario, there may still be good returns for these late stage investors. But there may not be.

Left out of this discussion is the IPO. I do think we will see a resurgent IPO market this year and going forward. But entrepreneurs are waiting longer to take their companies public and that's a very good thing for everyone. With the emergence of this new layer of late stage/primary+secondary capital, we can all wait a bit longer. And not sell out. And that's a very good thing.

#VC & Technology

Comments (Archived):

  1. Pascal-Emmanuel Gobry

    These are all great points. We saw a preview of the “DST deals” with LinkedIn’s mega financing with Bain Capital a while back.One thing which is tangential and I want to highlight is this great sentence: “Silicon Valley is all about recognizing a good idea and running with it.” Indeed.

  2. Niyi

    I think this trend is a natural consequence of the combination of three factors.1. Rapidly decreasing cost of creating new startups and consequently the reduced need for substantial capital in early rounds.2. Increasingly large funds that VCs are raising and consequently the need to invest substantial capital in order to get a decent ROI.3. Fairly static liquidation preferences over time.That these companies now have to become very large profitable companies is a double-edged sword. Not all will, but hey that’s why it’s called risk capital.I reckon “DST deals” are better that M&A because the founders will most likely still run and provide strategic direction. M&A on the other hand tends to destroy shareholder value more often than not.

    1. fredwilson

      excellent comment Niyi. that’s exactly what is happening

      1. falicon

        Sorry to post this in the wrong spot (having troubles seeing disqus on the actual blog right now, so posting as a reply via your profile)…anyway, just wanted to point out that since I’m not “in the know” on VC stuff, it took me a while to realize that M&A stood for mergers and acquisitions…so just a friendly reminder that spelling out acronyms at the first mention for those of us that are still learning is a big help 😉

        1. Mark Essel

          I didn’t recognize it either but context let me know it was BigCo.

          1. ShanaC

            Just because it is M & A doesn’t mean it is BigCo. Big is relative and has to do with company culture as well. Plus you can have companies of parity merge- all sorts of companies do mergers including private ones that are small…

        2. fredwilson

          my bad, great point. i need to constantly remind myself not to blog in shorthand

          1. Tom Foremski

            You’d think your readers would know what ‘M&A’ is. It’s hardly an obscure term. What are they doing here?!

          2. ShanaC

            There are a large variety of readers here from all sorts of backgrounds doing all sorts of activities: A good assumption when writing is do not assume that the reader knows everything-if the Wall Street Journal can write down mergers and acquisitions, so can Fred.

          3. theslingster

            If you go to a Cardiac Dr. forum, do you expect the members to dumb down their conversations for non doctors? Or a bio-tech forum? Etc.?These blogs aren’t about entry level stuff (there are plenty of web sites you can go to for that), but about special interest groups using their industry vernacular to speed up the conversation…not to frustate a newcomer!!

          4. ShanaC

            I do look stuff up all the time just to be sure. And I was frustrated in the beginning. (I think I’ve looked up FTW at least three times) And I took a class, and convinced a friend to give me her notes from a different class to make sure I can understand what goes on here. Yet at the end of the day, you’re still talk to an undergraduate art student. Some people like learning for fun, and will hang out on the web to do so. Get over the fact that people come online to do all sorts of stuff, including perhaps learn one day about the differences and similarities between venture capitalism and private equity. Tomorrow the same person may want to learn about, I don’t know, how to make beer. (Note I do not want to learn how to make beer)Joy of the internet…you really don’t know who you will run into, and what it can teach you over time…

          5. fredwilson

            that’s true, but it’s not that hard to write mergers and acquisitions instead of M&A and it broadens the discussion when you do that

    2. Mark Essel

      Great points Niyi. Founders may be the best leaders of the new business. But some may not be interested or able to manage a large corporation.

    3. ShanaC

      This makes it sound like Prvate Equity and Venture are moving closer to each other. This also makes it sound suspiciously like in theory as has happened with private equity, you could keep some guppy companies indefinitely private and continue selling through funds…

    4. Aviah Laor

      “M&A on the other hand tends to destroy shareholder value more often than not” – so true.But for founders in their first exit, sometimes $5M in the bank is better the $100M on the tree. Maybe an important part of the new trend is to give the founders a safety net, in cash, before the exit, a compensation that traditionally regarded inappropriate.So many promising companies and ideas where kissed the M&A kiss of death too earl, just to provide the founder an earlier exit point, and , even if the price of watching your creation goes down the M&A drain.

      1. fredwilson

        yup. i’ve seen it first hand enough to know that we should be giving them the cash, not big companies

    5. Lawrence D. Loeb

      Niyi:I understand, and agree with your first two points, but I’m not sure what you are referring to in regard to liquidation preferences. They remain static until there is a new funding round, or if they are renegotiated (for some reason). That’s fairly consistent (although, as you noted in pt. 1, there are less funds needed and, thus, fewer rounds – if the company can reach positive cash flow).What has changed from the earlier (let’s start with the ’70s as a reference point) is entrepreneurs favoring M&A over VC. Typically, entrepreneurs want greater independence, to follow their vision, and to build a successful company that they could IPO (which has, generally, proven to provide higher valuations to the earlier rounds). There are, of course, many exceptions, but that would describe a large majority of situations (Fred, please correct me if I’m wrong here).Both institutional VC and M&A lead to some loss of control but, generally – since the VCs are looking for the best outcome on their investment – they are focused (until there is significant negative evidence) on the original vision.On the contrary, most corporate acquirers are looking to integrate their acquisitions, to some degree, with the rest of the company. There are generally greater governance, compliance, and other issues associated – particularly if the acquirer is public.It’s interesting to see the markets continuing to evolve (unlike Fred, I’m a former VC and now an observer).I would expect that, as the IPO market returns, large VC rounds will prove more attractive (and less dilutive) to firms seeking pre-exit capital. M&A will return to its role as an exit opportunity when an IPO cannot be executed on acceptable terms.I agree with all of the comments made about the headaches for public companies (particularly financial institutions). The compliance costs that are required for a public company are astronomical when compared to a private firm. IPOs, however, HAVE historically provided greater returns to early investors.I don’t believe that the additional charges have had a large impact on the IPO decisions made by entrepreneurial companies

      1. Niyi

        Hi Lawarence,You’ve raised excellent points.Regarding static liquidation preferences, I was referring to the earlier rounds.As long as VCs don’t compromise on high liquidation prefs (commensurate to risk of course), it’ll make more sense to invest in later less risky rounds where liquidation prefs may be lower but at least they can deploy a substantial part of their fund.One more point – that DST deals are occuring in greater frequency is a leading indicator of a resurgent IPO market this year or next. That’s a good thing.:)NiyiSent using BlackBerry® from Orange

        1. Lawrence D. Loeb

          Hi Niyi,I’m still a little confused. Early investments can require liquidation preferences that sometimes get to 2x to 3x the initial cash investment. That’s true.It is not necessarily a disincentive for new VCs to invest, because those liquidation preferences can always be renegotiated.It all depends on the cash needs of the company and the willingness of the original funders of the business to provide all (or most) of the cash to meet those needs.If the existing investor needs another firm to lead a round (to set a valuation that will be acceptable to their auditors and clients), that new firm will have significant leverage to avoid future dilution (a simple solution being an equivalent preference clause with the two class shares treated on a pari passu basis). – In general, new money makes the rules.I believe the issue that you are referring to relates to the way that VCs set up their business. Many VCs specialize, and one aspect of specialization is the stage and size of the company. These are particularly helpful in early rounds where there are limited cash requirements.It is my understanding that there is still a somewhat robust group of early stage VCs, however, changing conditions in the VC markets often entice (or force) mid round, and even final round VCs to wait longer before investing. This reduces, theoretically, their risk while also reducing possible returns.

          1. Niyi

            Hi Lawrence,I agree with you. Yes, liquidation prefs can be renegotiated, especially when a new, higher valuation has been set, and the business derisked further.As you noted, earlier round liquidation prefs (required those still willing to invest at those stages) still remain around 2x – 3x. That range has been ‘static’ for as far back as I can remember. It is quite rare to hear of early stage liquidation prefs dropping below 2x. All based on empirical evidence of course. :)Having said that, you are correct when you point out that there seems to be a robust set of VCs who have specialized on early stage funding.I suspect that this niche will be filled by new entrants (angel cum VC) as we’ve seen with Marc Andreessen and Ben Horowitz’s new fund, and Dave ‘500Hats’ McClure’s new fund. Traditional VCs (with their increasingly larger funds) are as a natural consequence, starting to focus on mid to late stage (DST-style) rounds.Niyi

    6. paramendra

      M&A for companies like Facebook and Twitter would be blasphemy. These are companies that need to go public.

  3. alan p

    A thought – is there any financial engineering benefits that these sorts of deals attract that pure M&A doesn’t – ie the returns may not be from direct buy/sell multiples.

    1. fredwilson

      these deals sometimes have “structure” but often do not. so there is a role for financial engineering to play. but that is not the driving factor behind this emerging new layer in the capital markets

  4. kidmercury

    “But it appears that VCs are making a strong comeback led by newly energized later stage investors and even some hedge funds.”just stimulus money trickling down. that’s how it works in a fascist economy! meanwhile gas prices are rising, now that the bailed out banks can go back to bidding up the prices of oil. you can see the wealth transfer in action.I do think we will see a resurgent IPO market this year and going forward.maybe, if the bailouts and monetary policy can transfer enough wealth from dollar holders and US treasury bond buyers to the US financial system. might not be enough wealth left to transfer, though, let alone the obvious moral issue. anyway i don’t know how anyone can watch this and think it is a good idea to have their company publicly traded.

    1. Mark Essel

      All roads lead to virtual currency, nice way to rain on the extra cash flow Kid. I didn’t see that connection. It’s not as “far out” as I expected either.

      1. kidmercury

        lol, all roads lead to virtual currency for sure! unless we choose ignorance, then the new world order marches down the path of one world government and one world currency (whose supply is pegged to carbon credits, of course)……

        1. fredwilson

          the regulars here (JLM, Kid, Arnold, Mark, Shana, etc) all seem to like to talk about virtual currencies. this post had little to do with that and yet here we are back to talking about it. that’s worth noting. something’s happening here.

      2. awaldstein

        Mark, a bit off topic but pertinent to the ‘whys’ of virtual currency that are relevant for your start-up trying to figure out commerce. Two great things about virtual currency; 1) they allow micro transactions (for tiny payments transaction fees are prohibitive. But buy 100 Essel bucks for $10, then charge 1 Essel buck and you are good), and 2) you are not holding dollars that accounting wise have to be returned as the transaction is about buying the currency not the goods itself.

        1. JLM

          I have been thinking about the issue of virtual currency as I have a business which could use it in a big way. There are a couple of interesting aspects that intrigue me.First, is the issue of “breakage” which is the amount of virtual currency which is lost, destroyed or otherwise does not make it to the POS. This could be significant. I am led to believe in the “one off” VISA gift certificate business it may be as much as 15%.Second, is the accounting for the amount of currency outstanding. Tied to a business this would result in an accounting liability (the value of the virtual currency outstanding) and an asset (the cash backing up the virtual currency).Accounting logic seems to indicate that at some time when the amount of breakage begins to be identifiable that an accounting entry must be made to recognize the value of the “income” derived from the issuance but non-redemption of the currency.

          1. Mark Essel

            Sounds like handling virtual currencies can be a tricky accounting issue. Probably best for an pro to juggle to make sure everything is kept track of.

          2. awaldstein

            Hi JLM.I as well have a client who this is appropriate for and noodling this over.My responses to your smart questions in order:1. I don’t know that there are any public metrics but 15% sounds easily correct. It is the same somewhat as gift certificates not cashed in. This is a net positive of course over time..or at least not a net negative as the transaction in this model is for the currency itself, not for the object being purchased.2.I would think it is an asset, or at least so in the way I am considering structuring it. In fact, one of the reasons for going to virtual currency is to remove the liability of unspent accounts. Fred, from his experience with his FB gaming companies probably has some facts but may not be able to share. Re: your conclusion, I’m not sure honestly. I am almost at the point of taking a current structure of virtual bucks to legal to figure out. To repeat, my movement towards this was to A) let me deal with microtransactions without being slave to the cost of credit card sales, and B) remove the liability from the books of ‘breakage’.Let’s keep in touch on this.Thnx for the questions

          3. ShanaC

            JLM I know we break apart on this issue- but once you go virtual on the currency, you effectively make way for more complex investements via derivatives. Derivatives mean that the money is cross-redeemable (whether this is constitutional or not is a whole other story). Without the money being cross-redeemable, what’s the point? You have to have ways of money exiting and entering the system en mass.In fact, those Visa Gift Certificates are cross-redeemable. You can go to a matching bank and get straight cash. (I’ve done it, I wanted to deposit the value of the certificate) They’re m1.If breakage appears with “real” money, and the problems you are talking about with virtual currency are appearing as well, I would want the system to be as liquid as possible. Not only is a liability for accounting purposes, it’s a liability for those who will have to make guesses about the future of their business suppliers that that use virtual currencies (just like there are people who have to rely on the oil derivative markets so they can ship goods) Cross-redeem and real banking privileges..that includes the street as much as people dislike the street. If people need to be out of a currency or in on a currency, that’s their business. Bring on the USDX of virtual currencies.

          4. JLM

            Very thoughtful post. I suspect that the ability to “redeem” a virtual currency for cash (which is at the end of the day a financial backstop for the “real” value of the virtual currency) is the tipping point at which your currency is either sustainable or is just a “chit” holding the value of the underlying cash for a short period of time.The real long term upside is in creating a “sustainable” virtual currency that is never really redeemed but might be “called” by the issuer.If you think about it, this is exactly the dilemma provided by severing the US dollar or silver certificate from the underlying metal collateral or value.In my application, I am contemplating using the virtual currency in a gambling venue in which the prizes are paid in part in virtual currency thereby creating a “use” for the virtual currency which transcends its function as only a storage instrument for value.The upside for me as the issuer of the virtual currency would be the breakage and the earned interest on the money backing the currency. If annual breakage were 15% and I could earn 4% on the currency reserves, then it would be an attractive arbitrage possibility which would encourage me to have as much virtual currency outstanding as possible.One downside would be the counterfeiting of virtual currency.In some ways there is a model to follow. The US military used to issue MPCs — military payment certificates — in countries in which they were trying to discourage the circulation of US dollars (e.g. Viet Nam during the war and Korea for years after the war). The military issued them in different colors which changed about every six months. This created a huge artificial amount of breakage when the colors were changed as the expiring color was rendered worthless by the issuance of a new color. Only soldiers could trade color for color so all MPCs in the hands of the local populace were worthless.

          5. ShanaC

            Now that’s a high complement. Can I keep the comment in case I mysteriously need it for grad school (not that I know what I am doing yet…)Digital currencies have a whole different set of problems than say a pile of dollar bills. We do know that bank accounts (which are digital, though I really think it would be fun to try diving into a pile of dollar bills), have been cracked and stolen from. There is no reason why you couldn’t copy the cash instead of steal the cash if you are someone who is going to crack open an account anyway (don’t listen to what I say, if you do this, I absolve myself of guilt, you crook!)IN practice- don’t we redeem cash through the federal reserve selling of treasuries? and aren’t treasuries of all sorts debt instruments? And haven’t we stopped needing actual bonds…just the number. I mean in truth you could wait out the bond…The question is, can you float real debt in the name of that currency? But effectively that we be a form of Sovereign debt- how tied would it be to the company?I can’t imagine the MPC system working very well in practice at all. I can imagine people importing dollars and inflationary pressure on those dollars being sky high (where $1 is worth who knows how much in practice). Currency only works if it there is a guarantee that it will work (yes I know that sounds circular, that’s money for you), otherwise you get flights to quality and social unrest….Not that I was in vietnam, yet I still can imagine a thriving black market there in dollars or gold because of the weirdness in money. Or a thriving black market in general because of the weirdness in money. And black markets are really hard to regulate into white markets. No offense, free markets are usually not black markets…

        2. Mark Essel

          Groovy Arnold, great points on virtual currency. Tyler and I have hashed out some game type rewards with a scoring system that we wanted to reward folks with some form of virtual currency. It’s not on our immediate plate though (trying to get things clean and fairly bulletproof before we meet with Robert Scoble in June).

          1. awaldstein

            I’ve long been a proponent of taking social gaming structures to the social apps arena as hey, they are a good infrastructure for fun and we all need more of that.Natural offshoot was the currency item. Micro transactions for high volume (and distributed) apps always show up as a model and always break down because of the transaction cost. Virtual currency is one way to address this. Pls do share any others you are thinking of.

  5. Fred Destin

    tiger global, the hedge fund, was probably the pioneer in these kinds of dealssee

    1. fredwilson


  6. Brian Billingsley

    Great stuff, always enjoy the content of your posts. I can’t speak for the entire market, but in payments if M&A and VC were juxtaposed wavelengths, one would be at it’s peak while the other in the trough. Right now VC action is ramping up – partially due to the fact that most of the big companies and cores have recently made big purchases that they are trying to absorb. Obviously there are many other factors that play in…Thanks again for the great content!

    1. JLM

      Very interesting, insightful and illuminating way of looking at the financial markets.

  7. Nick Oliva

    Do you know whether there are penalties associated with targets that have to be met in the next few years by the companies raising these subsequent VC rounds? Typically, of course, there’s a desire to avoid VC money when there are other alternatives because of the pressures involved, etc. Is it possible, in your opinion, that the founders and earlier stage investors may live to regret these deals?

    1. fredwilson

      i do not believe these deals have any “targets” in the sense of financial hurdles they need to hit. i could be wrong as i am not close to all of them. but i think they are all pretty much “plain vanilla” deals

  8. SM

    The question of returns at late stage financings is a good one. I think the late stage investors have VC type returns in mind, say a 3x -5x expectation. I think that this is achievable based on revenue growth which could be substantial as the early stage (in percentage growth), but think that many of the investments are going for the quick momentum flip while brand value and comps are rising, and some large corps have acess to cheap cash.

  9. giffc

    in M&A activity in 2004, it was surprising to see financial buyers outbid strategics, and at Broadview we saw it happen repeatedly. I’m out of touch with the trends at this point, but my guess would be that private equity folks have gotten much more conservative in this environment. It would be interesting to know how the valuations of late-stage VC investments are comparing to the probable, and refused, acquisition exit amounts.Without doing any research, it feels like VC valuations (driven by competition by too many big funds) are a fair bit higher — is that right or does my brain need more caffeine?

    1. fredwilson

      higher than private equity valuations or something else?

      1. giffc

        deleted a longer clarification because I realized my question is simpler: do you think there is an irrational valuation bubble emerging among these late stage funds as too many chase too few opportunities?

        1. fredwilson

          could be. a lot depends on what these companies can grow into.

  10. andyswan

    Going public just isn’t nearly as attractive as it used to be.Now you’re subject to explaining your company’s compensation approaches to the government?Soft-tyrants UNCONSTITUTIONALLY deciding to tax your entire industry, and only your industry, because they blame only you for the woes of the economy and want “their” money back that they forced you to take along with GM/AIG/Fannie?Called into DC to tell idiots that think “profit” is a bad word, that have no idea about your business, why a certain voting block of theirs isn’t yet “benefiting” from your products and services?Constant regulatory changes that make you more accountable to the government than your shareholders?Give me a break. A war on business has been declared and the smart players are laying low until the backlash gains ground (which is going to start to happen tonight in MASS)

    1. Mark Essel

      Pure capitalism, nice Andy 😉

    2. kidmercury

      that’s right andy!!! only when we stand for liberty/capitalism (same thing) will we get our markets back. so long as the youngsters take the easy bait and go for the fascist handout, the problems only get worse. got get the crooks out of the way, then we can go back to making cool things and taking it to the bank.

      1. iamronen

        two intense words liberty & capitalism – I don’t know if I could couple them together so easily/obviously – liberty I associate with freedom – and this is my take on it:… – as for capitalism I haven’t consciously processed it enough to relate to it seriously – but I believe this offers a very interesting and different perspective on what I believe capitalism tries to achieve:…when I first read this post I put it aside – it didn’t relate to me… a day later I recognized in it a movement away from “public” and towards “private/intimate” … ideas and wishes are kept closer to the heart, in smaller circles of people who care… given enough time I wonder if this could move into the realm of conscious giving & philanthropy (in a way it’s already there – every company that didn’t make a return on the money was an act of philanthropy!)…Fred – have USV participated in a “DTS deal” as a late investor? Would you?

        1. fredwilson

          no we have not and yes we would under the right circumstances

    3. JLM

      It is not just a “war on business” as you so rightly indicate, it is a war on the most productive slice of America which has spawned the ideas and taken the risks, which have built the companies, which have created the jobs, which have fueled the economy.It is a war on success.You cannot simultaneously make war on the most productive segment of America and then offhandedly tell them — OH, YEAH, BOYS, CREATE JOBS — and expect to succeed.This is the evidence of inexperience and an immature sense of the American economy. Capitalism — raw, red meat, work hard, take risks, get rich and enjoy it capitalism — has delivered the world’s highest standard of living to the US. It is a damn good system. Sure it needs a bit of guardrailing from time to time but left to its own devices it is the best game in town.In capitalism, if you break it you bought it and if you kill it you get to eat it. Eat well, capitalists!

      1. andyswan

        No question. Our “poor” live better than 70% of the rest of the world 200 years after our founding, but because someone else in town owns a private jet, we’ve got to tear down the whole damn system in the name of equal results.It’s as if the basic behavioral psychological truths of incentives and consequences are to be completely ignored. Mind-blowing.It would be hilarious to ridicule if it weren’t so pervasive….and in power.

        1. Lawrence D. Loeb

          To be fair, I think it IS appropriate to provide the poorest of us with a safety net that provides for most basic needs (with incentives associated with greater productivity providing greater comfort). This type of system is, however, almost impossible to run bureaucratically – to many incentives to cheat, bend the rules, etc. It’s more of a Utopian type hope, but I think it’s something we should strive for.We particularly need to provide for sufficient nutrition and education for our children. We must provide the children of the poor the opportunities to reasonably aspire to, and achieve, more than their parents.Children are the future (I know, a VERY overused phrase – but it’s still true). Being born poor does not mean that a child won’t achieve great things; but without nourishment to develop the body and education to develop the mind, the probabilities are greatly reduced.As for our poor being richer than other countries’ poor, that’s a little misleading. In many, and perhaps most, of those other countries the cost of living is much much less than in the US. It is not as tragic to live in a hut by the ocean in the tropics living off the fish that you catch from the sea than it is living in a shanty town or flea-bag hotel in most of the US.At least that’s my opinion.Just to be clear, I’m not in favor of income or wealth re-distribution. I am a capitalist with strong Randian leanings. I just don’t take it to it’s Darwinian extreme and believe that the weak should be allowed to die and their offspring have no future anyway.Science has taught us that a child of parents with low intellect can still be genius. We shouldn’t lose that to hew to an extremist view of a philosophy.

          1. fredwilson

            you and i are in the same camp Lawrence. i don’t want to be part of any system that doesn’t take care of its neediest

          2. andyswan

            Neither do I. I just refuse to turn that responsibility over to the most corrupt and inefficient organization in the country, instead of taking it head-on myself as an individual.Compassion-at-gunpoint and compassion by ballot doesn’t work. It turns people into lazy givers and lazy recipients. This is why “systems” like Detroit, New Orleans, Oakland and NYC continue to grow the “recipient class” every single year, despite the best of intentions from high-confiscation, mostly well meaning liberals being rubber stamped decade after decade.The “system” does NOT have to be the government!

          3. fredwilson

            i don’t see that happening in NYCin fact, i worry that soon the poor won’t be able to live in NYC

          4. andyswan

            Lawrence we agree on the goals (something liberals/conservatives etc typically miss about each other)…..I just cannot see any reason to leave the solution up to government.Show me an area where the producers are taxed the heaviest and the “system” is set up to help the poor the most, and I’ll show you….WITHOUT FAIL…..a place where the number of poor and dependent are growing, the schools are failing the hardest, and the producers are leaving the fastest.

    4. Donna Brewington White

      I think you’ve nailed it. (IMHO)

  11. CharleySevers

    A rebuffed m&a deal almost has to be followed by a financing (with secondary) if for no other reason than to keep employees happy by letting them make a little bit of $

    1. fredwilson

      right, but many times in the past that was not the case.

      1. JLM

        Mature financiers go to the equity markets when the money markets are most advantageous to them not just when they “need” the money.The old banker joke is of course painfully true — “if you can absolutely prove you do not need this money, we will lend it to you!”Mature companies price money as a commodity comparing the cost of debt v equity as a dispassionate cost in terms of direct cost, interest expense, impact on the balance sheet and compliance with debt ratios.

        1. fredwilson

          my wife and i just repaid a loan on a personal investment that was incredibly difficult to obtain. she wanted to rub that in the nose of the bankers. i told her to let it go. bankers are bankers. they’ll never change.

  12. Mark Essel

    “With the emergence of this new layer late stage/primary+secondary capital, we can all wait a bit longer. And not sell out. And that’s a very good thing.”Patience is the name of the game for VCs & founders. But there may be cases when the business becomes disrupted before it materializes. The risk doesn’t go away completely for later stage startups. Also the M&A strategy may be incredible for all involved parties. YouTube is a great user experience, and it’s losses have been subsumed by Google and will almost assuredly turn the corner. Had they waited they may have collapsed under costs and become a much cheaper buy.By the way, top notch post Fred 10/10

    1. fredwilson

      youtube really had to sell. they could not absorb all the litigation (rightly or wrongly) that was coming their way

  13. ipostelnik

    I think your last paragraph is the key. These financings are a reaction to very poor IPO market. In the past these companies would just go public. Now that that’s no an option, these alternatives let founders take some money off the table without selling the company. I wonder how long this will continue.

    1. fredwilson

      i don’t think that’s right. it’s a reaction to not wanting to be public. if facebook and zynga wanted to be public right now, they could be. easily.

  14. Chris McDemus

    It used to be that you went down the IPO path in order to push along an M&A deal. Now it seems like you push an M&A deal to move along VC funding. How times have changed.

  15. udeme

    Fred,I cc’d you and @dougw early this morning on this (re:Kickstarter).I believe the KickStarter model will attack the VC model sooner than many anticipate. While M&A may remain a viable exit model for startups, this disintermediated model for VC-ing will surely cut into the risk capital market. All it would take is for a “next-big-thing” startup to break into mainstream consciousness (Twitter-style), and the KickStarter model will be well on its way..Surely, tweaks in compensation/benefit/ownership systems will have to take place, and identity/payment infrastructure still has a few iterations to go, but its already clear that there is capital looking for investment outside the echo chamber of the NYC-VC circiut.Think “Investment Craigstlist” but more secure, ..and definitley more efficient..PS:Fred – Brilliant post on “ vs The Twitter Ecosystem”Niyi – Impressed. Trafficspaces is targeted, precise and robust.

    1. kidmercury

      for sure. the big issue is legal/jurisdictional. virtual currencies/game play can help solve that problem IMHO.

    2. fredwilson

      i’m not so sure about that. many entrepreneurs want more than money from VCs. but you are right that there will be a growing number of alternatives to financing projects and businesses, including kickstarter

      1. ShanaC

        If I were starting a company right this second, to be perfectly honest, I probably would want more in the way of advice than the money. Money is sort of useless if you don’t know what to do with it. That’s why it is called an investment.

      2. JLM

        And smart VCs deliver more, way more than just money. You might argue that money is almost the least important element of the investment made by a VC.A great idea wrapped in a framework of the very best business practices, the best professional advisors and best road map to the pay window only uses money as the lubricant.

    3. Lawrence D. Loeb

      There were many many many web businesses set up to fund businesses in Web 1.0 and (I believe) Web 2.0.For the most part, they weren’t successful – except as an adjunct to a normal fundraising process.It IS possible that those companies were too early, and the model can succeed now that there is even greater penetration of the Internet (and Internet commerce).As Fred said, VCs bring more to the table than cash. Depending on the group, they bring expertise, experience, relationships with potential partners, suppliers, and customers, etc.In the industry, the type of investor sought in the KickStarter model is known as “dumb money.” There is no value add from these investors. You also take the risk that some become more trouble than they are worth now that they “own a piece” of your business.It will be interesting to see how this develops.

  16. brianhirsch

    I’m not sure the “DST deals” are much different than what we all experienced during the last tech bubble. Firms like Baker Capital and several other late stage, “pre-IPO” large hedge/PE funds routinely funded companies that either had a lot of buzz in the press or had bankers stating they were worth a lot or game-changing in nature.The potential issue now as it eventually became then was that the valuations paid in these financings were often detached from the fundamental financials of the business. EBITDA multiples (the usual hallmark of a late-stage investor) is an afterthought. Instead valuation is set from real or perceived M&A or IPO exit value at a specific moment in time. As we know from the tech bubble, valuations not tied to fundamental financial metrics can be fleeting.If we’re honest we can remember that many VCs called these late-stage investors dumb money back in the day. Time will tell if history repeats itself.Clearly taking this money in and providing some liquidity to founders and optionality for early investors is a great move as long as the new, high valuation investor has no control or blocking provisions in place.

    1. kidmercury

      these valuations are completely detached from reality and are more reflective of dollar fear than they are of profit potential. P/E ratios are still comical, equity markets and unemployment rate are positively correlated…..hard to resist the temptation of high valuations though, that’s like free money. so long as you can get out before the party ends!

  17. Charles Birnbaum

    I used to sell technology IPOs in my former life and I agree wholeheartedly with Fred that it is a wonderful trend for both founders and the broader economy that companies are waiting longer to go through the excruciating process of going public.However, I would argue that even the best of the best are waiting primarily out of fear that they will not realize bubble-time valuations. Most young companies are not waiting in order to avoid losing control or exposing their sweat equity to the painful, mercurial whims of the equity market. There are many wonderful companies that are simply not large enough to withstand the permanent damage that a down quarter can have on a small cap public company. This DST trend is heading in the right direction, but does not solve the problem as it is only an intermediate step. What we really need is a trusted secondary market for equity holders in growth companies to find liquidity, not just in large, chunky transactions such as this Yelp deal.

    1. fredwilson

      right. but you need to walk before you run. this is the early stages of that secondary market developing

    2. JLM

      “Most young companies are not waiting in order to avoid losing control or exposing their sweat equity to the painful, mercurial whims of the equity market.”No truer words were ever spoken.Most young companies and VCs will struggle with having the equity markets ’embrace’ (“believe”) their own internal valuations. Just subjecting their cash flow assumptions and accounting to GAAP is a daunting task.

  18. GlennKelman

    I really like the way you are leading the trend on patient investment Fred.

    1. fredwilson

      thanks Glenn. it’s not purposeful or intentional. i just wake up every morning and write about what’s on my mind.

  19. Laurent Boncenne

    It encourages future entrepreneurs to build a business based on a possible sustainability instead of a potential M&A opportunity, leaving the “feature as a product” little chance to succeed.I view this as a way for VCs to say they want to help build more companies like Microsoft, Apple or Amazon instead of businesses with a short lifespan (3 to 5 years or so)…

    1. fredwilson

      that’s what VCs want to do because that’s how we make the most money.

      1. JLM

        There is a huge difference between building a great product and building a great company around a great product.Every VC is ultimately investing in the sponsors and people as well as the business or product.The VC is left with the difficult task of divining whether the entrepreneur is a builder of companies or a builder of products. Of if he even really knows.No indictment either way but it is a damn important consideration and may change over time.The ability to determine with whom you are investing is a critical VC skill.

  20. Tito Costa

    Late stage VC secondary deals (buying shares from previous shareholders) are a consequence of larger funds looking to deploy vast amounts of capital.It is great that such players can provide a liquidity event to entrepreneurs and earlier stage investors when the company has been successful in overcoming most of its risks. “DST deals” would then bridge the gap to an IPO exit that now (since 2001) happens later than it used to and really is not viable for companies smaller than $150-200M in revenues and already cash flow positive.On the other hand, it is hard for a late stage purely financial investor like DST to gain an edge compared to every other late stage investor and generate above-average returns. In the short-term it is probably good for earlier stage investors that will see growing valuations from competing late stage investors. But we shall see if that can be a sustainable model that can be beneficial for the overall ecosystem.Nevertheless I see the risk of a ballooning “hot-potato” effect: you pass on an overvalued asset to the next investor, who will in turn hope to find someone (another investor or the public equity markets) willing to pay an even higher valuation. If that sounds familiar, it’s because it is: private equity boom and bust, CDO/subprime backed securities, …

    1. fredwilson

      that’s true. but DST has been very selective and Facebook and Zynga are two excellent companies.

  21. Shai Goldman

    DST = Digital Sky Technologies (, some of comments on this post asked if they are “dumb” money, for those who don’t know, DST owns some of the largest web properties in Russia/E. Europe; you can argue that they know more about consumer internet than any other firm.One item that was not discussed in the post but is related, is how are these rounds are effecting the early investors and founders. These rounds could be used to provide liquidy to founders and seed/Series A investors, especially as the exit (M&A/IPO) is being extended further.Also, what is the possibility of these companies remaining private for 10+ years, which is beyond the life cycle of VC funds; the need for a secondary market is greater now given these mezz type rounds, otherwise VCs will not be able liquidate their positions.

    1. ShanaC

      Yeah why is there no such thing as a hand-off to Private Equity. Granted I don’t think that much debt is good, and these companies are young, yet you could keep a company private indefinitely in the right sort of fund.(Venture is not the right sort of fund)

    2. fredwilson

      excellent points. this is the beginning of a secondary market for founders, angels, and early stage VCs

  22. andyswan

    Isn’t a lot of this just veiled private-equity?

    1. fredwilson

      the term “private equity” actually includes VC in its definition. so yes

      1. andyswan

        OK I guess I’ve always thought of it as different. PE firm vs VC firm. Seems that PE players are simply reacting to the opportunity that an IPO drought brings and stepping in on some quasi-VC territory, although really high on the ladder, so far.Hopefully in 2 years will be writing about the “patient buyout” phenomenon 🙂

      2. ShanaC

        You don’t float massive amounts of bonds to keep people lean. And that’s the $64,000 question for me- does a secondary market create weird eventual debt issues? or slow development into more hybrid Private equity- venture capital funds to keep the companies private as part of a fund development (because now you can use debt more liberally)

  23. gordonplatt

    Just had CEO of Mount Sinai Medical Center (NYC) on Econ Forecast 2010 panel. He was very critical of VC market for biomed. Said 10 years ago, biomed VC’s were bombarded with calls and now no one wants to take a risk in his field. There’s only an appetite for late stage, sure-thing deals.If interested you can see a video (including his remarks) at http://blog.gothammediaventures.c (apologies for the self-promotional announcement, but I think it is relevant to the point at hand).

    1. fredwilson

      that may well be true. i am not a participant in that market. but from the sidelines, it seems that the capital requirements in biomed are so high that the early money can easily get crushed by the later money. that was starting to happen in IT and then we got open source, the web, web services, commodity hardware, etc and the world changed and early stage is where its at now

  24. Healy Jones

    I’m not convinced that this trend is here to stay. I also think that the non-execs at the companies raising the late-late stage rounds should probably try to sell some of their stock in these transactions. This whole thing makes me nervous.

    1. Phanio

      You just might be right. If the IPO market opens and investors want to get out – they will push them there as fast as they can – maybe.

  25. Aviah Laor

    Interesting Insights, as always. However, I suspect that this door is open only to the 800 pounds gorillas, and only after it’s pretty much certain that they are indeed the gorillas: Yelp, Twitter, Facebook etc. When other markets fail so miserably, these companies really shine. But by definition they are rare. Still in doubt if the secondary market will evolve for an earlier promising companies.

    1. fredwilson

      you are right that this emerging secondary market is currently limited to the top names. but that could change if people start making money with these investments

      1. willquist

        There is a market outside of Zynga, Twitter, Facebook, etc, nascent though it may be. We (industry ventures) are one of the few folks excited about investing later stage (revenue producing) businesses through secondaries and doing it on a day-to-day basis…

        1. Lawrence D. Loeb

          One of the interesting ways for growing private firms to raise cash is through a sale of stock to another company, often as part of a venture round.This can have positive and negative implications for the private firm. The benefits from such an investment can include the opportunity to work with an industry partner who may be a supplier or customer. The downside is that other potential suppliers/customers may pause at working with a firm that is part owned by a competitor.There have been very successful examples of this type of investment and some that are less so.It depends on the specific situation/market that the firm is involved with.

        2. fredwilson

          that’s great to know. where are you located?

          1. willquist

            San Francisco.

  26. Guest

    I think this’ll continue moreso in the future. Though big companies won’t need as many new products and innovations when everybody gets to where the world’s heading. It means startups need to go big or not compete.

  27. graubart

    No doubt this is becoming a trend. I think one of the key questions that comes out of this is what are the skills that VCs must bring to the table in order to add value to this process.Yes, there’s value in the cash itself. But, traditionally, VCs and Private Equity firms have had different skill sets. Even among VCs, there are different skills required for early seed-funding (where an entrerpreneur may have only a concept and needs lots of nurturing and hand-holding) vs later stage deals. Meanwhile, PE firms are often most skilled at accounting and in removing cost from the operational side.These larger, later stage companies often require a skill set than neither the early stage VC nor the PE firm typically provide. Founders are often good at getting a company to $10M or even $25M but are rarely the best to lead the $25M company to becoming a $100M company. Will these VCs be able to lend operational guidance to help drive that growth? Will they be able to tap into a pool of seasoned leaders to help drive that growth?I’ve worked with many VC firms over the years, including a number of Tier 1 firms; among them, it is a small few which provide ongoing value in helping their portfolio companies grow. I think that it will be no small challenge for most VC firms to succeed in this new market.

    1. fredwilson

      i don’t think my skills translate well to the later stages Barry. you need to bring new blood into the company, the board room, and ideally the cap table

  28. Phanio

    Great post. It is amazing to see new innovations like this – good for the companies, the investors and the potential shareholders should these firms ever become public.

  29. Elie Seidman

    Having a liquid market for the shares of investors, employees and founders of private companies will prove, in retrospect, to be as important a development in the history of American entrepreneurship as there is, second only to the invention of VC and PE. The vast majority of entrepreneurs who have built some initial value during the early phase of their companies developments will make better, bolder, decisions during the second phase and build more value as a result. The financial realities and risks that the participants in entrepreneurship face are real – you often can’t feed and educate the kids on startup salary. Freed from the risk of having the value they have already created become a zero, entrepreneurs don’t automatically become fat and happy and willing to take no risk. On the contrary, playing with the houses money they can swing more aggressively, stay in the game longer (instead of selling out) and build far more value. For investors, the ability to occasionally reevaluate their desire to hold the position helps them make better decisions – which is particularly crucial if they hold board power or influence.

    1. Aviah Laor

      “Freed from the risk of having the value they have already created become a zero” : great. exactly.

    2. fredwilson

      well said Elie. this is something i had to learn. i was taught that entrepreneurs get out after the VCs. for 100% of their equity, sure. but not for 10%.

  30. mattb2518

    You put enough money to work, you can get a decent nominal return even with a mediocre IRR. This is a good evolution of the market between sparse IPOs (and later stage at that) and a sluggish pace of strategic exits.

    1. fredwilson

      very true and there are a lot of investors making good money with mediocre returns using that model

  31. Donna Brewington White

    It was probably a post similar to this that got me started following this blog. Love this! (and the comments) Thanks, Fred. I learn so much here.

  32. danvers

    In the UK market we’re seeing M&A-lite transactions, where big companies (some of themselves being venture backed) are making offers for a large percentage of a small company on better terms than the VCs are offering. This has the added incentive for the target company of being a positive step towards an eventual exit and allows the bigger company to reap the benefits of the partial acquisition, when it might not be in a position to integrate the smaller company fully.

  33. paramendra

    2010 will be a great year. The 2010s will be a great decade.

  34. fredwilson

    i’ve met the DST people. they are very smart. of course, that doesn’t mean they will be successful with this model. but they do know what they are doing.

  35. JLM

    Running a little public company and having run fairly large private companies, I can tell you with great certainty that the supposed burdens and hurdles of public corporate governance and regulation are way overblown.Some of it is a learning experience the first time around but otherwise it is just a “monkey see, monkey do” exercise in following good exemplars for filings of all kinds.Much of what a public company does and complains of is simply a good disciplined business practice which private companies would be well urged to follow. Worst still is that most of the incremental regulation (SOx in particular) is about closing barn doors after the crooks have already looted the hay loft.I would be willing to bet that the single largest contributor to a weak IPO market is the lack of practice — everybody has gotten a bit rusty — compounded by the wholesale loss of talent in investment banking, bad experiences from financial sponsors of weak deals (the Dr Koop syndrome), the Thursday 2:00 PM discounted pricing charade, historic criminal mischief in the allocation of IPO shares and the time consumed in perfecting an offering without an assurance of its flying.At the end of the day, a public offering is a chance at the brass ring of getting an obscene P/E which may be obtained by a stock based M & A deal with a company which already has an obscene P/E.

  36. Aviah Laor

    No regulations known to mankind will show us the the customers’ yachts, yet they do succeed in limiting public access to promising investments.(and JLM, reading your comments is a pure joy.You are painting with the English language. Poetry about stock markets.)

  37. fredwilson

    it’s what they know. they own almost every major web property in russia