There Aren't Many Venture Backed IPOs
As a follow up to yesterday's post on this topic, here's another chart from Mark Suster:
So using the math I laid out yesterday (roughly 1,000 startups funded each year by VCs), this means that on average between 1% and 3% of venture funded startups get to an IPO.
To recap, 1-3% get to an IPO and 5-10% get to an M&A exit over $100mm. So 85-95% of all venture backed startups will either fail or exit below $100mm.
I am certain the VC industry is not using this probability of outcome in setting valuations right now.
It does come down to being realistic.Your assumption is probably right. Looking long, I’m going to stick with the conservative (assumed valuation) based on showing higher probability of the 10x where the discussion of strategy to achieve the 20-50x can be planned for discussion in the near future with much better data.Good job, I like the way you and Mark Suster are just being subtle. Maybe this time around if the frothy market is enhancing foolish investment, it will leave a stronger group of smarter Angels/VCs.
True enough. How do USV’S numbers compare to these? Have you had a portfolio company exit north of 100m or gone public?
we have had four or five exits so fartwo of them have been north of $100mm
You know, I’ve always wondered what happens to those companies after you “exit”?Do they still exist?
nope. they get subsumed into the borg
Well, exactly, Fred.They get bought by Google, Yahoo, those big companies.So where’s your BetterWorldism there?Really, you’re just funding the R&D for these big companies.You’re like one of those tech schools off Broadway or 6th Avenue that scouts talent and sells it to companies and takes a fee.
that’s why i prefer building a positive cash flow business and stayingindependent
But why is this a surprise? We always have the usual gold rush effect when the perceived returns are as high as they are being predicted for facebook, groupon et al.When investors perceive that they can make 1,000x + return, they throw caution to the wind and an effective land grab occurs. Most realise only a few will win and the majority will lose, but they still seem willing to gamble on these odds to try to pick one of the few.Along with a fundamental shift where, in a relatively small amount of time, companies can emerge, take large chunks of the market and get huge valuations/IPO’s there will always be an investment bubble.No amount of sanity checks from you and others will deter them, as they want to have their chance of making billions. Keep trying though as we also know that when the bubble burst it has a damaging effect on tech investment.
Well i think high valuation has many advantages, one of them is it encourages a lot of people to be businessmen and entrepreneurs. People who work in different fields such as biology, engineering, tourist, art, education and sports…… All of them see that if they quit their jobs and start a new adventure, they can be winners.Best ideas come from combining different things from different fields and make just a new product that is gonna serve other people (custmors).Of course valuation has not to be very high and exceed the limit, otherwise the balance will be broken, and the whole industry will fail.
a lot of weak entrepreneurs show up late in a cycle
What can I learn from this as an entrepreneur, or is all this more of a distraction? To me this just reinforces that I need a value driven investor, not a market-driven.
Totally agreed in theory. But the current practice isn’t following your wisdom, unfortunately.
I think the “industry as a whole” may not be following this in practice, but…If I have a good product, and there is demand for my product in the market, and I have an investor committed long term, I don’t see how the above information makes much of an impact on my decisions.
You’ll be surprised how logic will defy you, in reality. It sounds simple in theory, but not easy to implement. There’ll be gazillion other products saying the same thing as you are, and you have to raise above the frey to make an impact, among other things.
ha and most start ups think marketing and brand are a waste of time. Take @tobi:twitter (from Shopify) who was speaking at MESH West with me on another panel. He said that marketing is what you do when you don’t have a differentiated product. Great sound bite. Fast forward fifteen minutes later when he talked about wasting the first two years because he didn’t know who his key early market was (which turned out to be designers). i couldn’t help but think that a great marketing partner coulda helped him figure that out and he would have paid some $$$ but saved 2 years lost in the desert.
Sounds like someone else I know…. “Marketing is for companies with sucky products”
Agreed 100%.Marketing when artfully done is almost invisible.
Well said…A ‘like’ wasn’t strong enough.
Clients that are successfully and publically using your products Is the best marketing, but promoting that usage isn’t always easy. Sometimes you need to use sucky old marketing techniques to bring this to light.Ps I find it hard to compare ipo exits over last ten years. Seems lime there were a couple of outlier years and that more Startups are seen as cost effective incubators for large, risk averse companies.
I suggest you, as an entrepreneur, thoroughly understand the term sheets with which you are presented and how to align interests and counter those proposals, by knowing which investors get paid what at various anticipated future exits. You can do this by licensing Capitalization Analyzer from http://www.allrounds.com .
But isn’t this just a snapshot of something that’s still in motion? Assuming there was a good funnel of quality companies that are in the pike for making it, such that the the 15% can be increased- won’t the math get better say over the next 12-18 months? I know you said the quality of the funnel isn’t good yesterday. So, are you implying also that there are too many companies getting funded to the point where the quality factor is dropping, which makes the exit probability numbers drop too? I would argue there’s a surplus of innovation right now (I have an upcoming post elaborating) which the user market is having difficulty absorbing. Something is going to give. Users will flee some non-sustainable apps, whereas others apps will consolidate their position. I think we’re at the beginning of this consolidation where new market leaders will emerge in the various segments.
maybe but i don’t think so
It’s kind of like when you ask 10 people if they are good at something and they each consider themselves “above average.” Half of them are wrong.
No, 9 of them can be above average.
Great data, thanks. If you consider all of the startups that don’t get venture funding, it makes the odds (from the entrepreneur perspective) even more daunting. It really underscores the passion, conviction, and hard work it takes to start and grow a successful business. Cheers entrepreneurs!
At what point does an entrepreneur, then, have to walk away from a deal because the pre-money valuation is too high?A crazy hypothetical:Let’s say I have two Series A offers on the table. One would give me $3MM in funding at $10MM pre (I give up 30%). The other gives me $4MM funding at $20MM pre (I give up 20%). Neither is likely to get me enough runway in and of themselves — you’ll almost certainly need a Series B.Conventional wisdom says take option two, and in this case, that feels right regardless. But at some point, doesn’t the expected, reasonable exit of say, $75MM change the analysis?
Neither. I would say- take $2m on $10m.
Plug in some exit numbers and timeframes into the terms sheet of each deal. Then do the math: Which one will get more money into the hands of my CURRENT shareholders? That’s your answer.
—-Then do the math: Which one will get more money into the hands of my CURRENT shareholders? That’s your answer.—-Good one.
You’ve hit the nail on the head, Andy, though I would state it as “plug some exit numbers and time frames into the terms sheet of each deal…along with your current cap table and possible terms sheets for future rounds. Then do the math.You can use Capitalization Analyzer from http://www.allrounds.com to do this, enabling you to analyze more scenarios than the party on the other side of the negotiating table…in just minutes.
don’t take money from an investor at a price that is higher than what you think you can sell the company for
Now *that* is a really good nugget of wisdom.
I don’t buy the math on any of this. There’s no way the avg of 1000 angel/A rounds is a $20m val. Maybe 1/4th of that….maybe. (EDIT: Unless you include Color)In any event, I have no problem with Fred publicly telling other VCs and angels that the prices they are paying (and thus forcing him to pay) are too high. He’s an honest guy and that’s part of a marketplace.Entrepreneurs of Fredland: This has almost nothing to do with you. You have absolutely no obligation to anyone or any industry other than your current shareholders. Get the best deal you can and don’t worry about how Fred is going to afford his next bottle of pappy.Angels of Fredland: This is a great example of one category where you have a significant advantage over VCs. When the market gets frothy, you can do something that VCs can’t: Don’t invest in anything if you don’t like anything!I can 100% guarantee you that in the archives of AVC there is not a single post showing with this kind of certainty why early-stage deals are being priced too LOW.
I agree for the most part, Andy, but doesn’t that metric of “the most money for my shareholders” break down at some point?Let’s say I’ve got a really hot startup going for the gold (i.e. not the X of Y imitator). My seed valuation is $2mm and I have term sheets for (a) $2mm at $10mm post or (b) $5mm at $28mm post, then (b) delivers more money to my shareholders right now, on paper.But that’s a whole different level of risk for those shareholders if suddenly a $75mm acquisition is no longer a satisfactory plan B.If you’re a seed stage shareholder, where does that consideration come in for you?
Neither delivers money to shareholders NOW.My point was to take the anticipated exit point for each approach, plug in that number to that term sheet, and see which one would deliver the most money to your current shareholders at that point in the future.Each term sheet could have it’s own “anticipated exit” because the strategy may change…but in any event what should drive your decision is the “expected return for current shareholders”.
Got it. Agree completely.
100% right.These two posts have better described my sentiment that I could.Yes you raise $2M with the same exact terms go for the least dilution possible.But taking $5M if really what you need is $2M (after as Mark says you took double what you thought you needed)It doesn’t mean crap if you are not taking money off the table.
Agreed. And if you really want to understand which investors get paid what at anticipated future exits, license Capitalization Analyzer from http://www.allrounds.com .
I understand this line of thinking and I encounter it often. But the “get the best deal you can” does have a downside, too. People need to consider whether they’ll need multiple rounds of capital. If you get a huge valuation now & need to raise in 18-24 months again when the market is corrected it can become destructive.I made this mistake myself as an entrepreneur so I know. I raised in Feb 00 and then again in April 01.I like to encourage people to raise “at the top end of normal” but not above normal. Meaning if the norm for the past 10 non-bubble years is a $4 million valuation and you can raise at $6 million no problem but if you raise at $12 million you might find your next round more difficult unless you absolutely kill it (or raise again before the bubble ends)
We agree. I don’t want the handcuffs of preferred shares on too tight as I mentioned yesterday. I’m just trying to wave a little flag here that “we” don’t need to be worried with VC industry returns. There is no altruism at the bargaining table.Totally agree that you have to maintain future flexibility.
What this thread shows is that people start thinking about the time after the bubble. One line of thinking is: Take as much money as you can as long as it is available. The other line of thinking is: Form a company that is reasonably financed and doesn’t burn cash, and you will have a chance to survive the bloodbath. The logical best way to go for founders would be to take as much cash as they can and then put it in the bank and run a lean operation. But I doubt VCs will let them do that.
Raising at big valuations does not necessarily mean raising big sums of money (even though they go hand in hand). If an entrepreneur is steadfast on keeping the amount raised to a normal level, they will not need to worry about pref handcuffs after frothy times pass – they will instead enjoy the additional ownership they have in their company!
unless you are another VCthis post and yesterday’s post was not directed at entrepreneursit was directed at me and others in my line of work
Yes, what this post is is Fred arming his competitors (and sowing some ideas into possible future investees) with an argument to lower expectations and make the deal a lot sweeter for the poor old VCs who are just barely getting by.You are dead on when you say that there you will find no post expressing with such certainty that valuations are too LOW. I wish I could like your post more, Andy.So, in the interests of AVC transparency, I will say this clearly: I call bullshit, Fred. This is just one of those (thankfully rare) self-serving posts that mar and otherwise wonderful thoughtstream that is the AVC blog.
it is both self serving and a siren to me and all my colleagues in the VC businesswe are in a phase in the cycle where we will not make money
Not by investing. But by selling investments you will.
Fred,I think there is some (optimistic) calculus going on here – and I’m curious asto your thoughts on the following:Let’s use your assumptions, giving us the following:1,000 total deals10 IPOs (the low end of the range)50 M&A exits above $100mm (the low end of the range)250 sub-$100mm exits (I have added this assumption)690 deals that are utter failures with no returnPre-money valuation on each deal: $10 mmCapital deployed on each deal: $10 mmM&A exits will be assumed to average $250 millionWe’ll continue to ignore follow-on round issues for the sakeof model simplicityThis leaves us two significant “unknowns” to “plug – average IPO values and average sub-$100mm deal values.I think this is where the real inflection occurs – especiallygiven the rise in IPO valuations since about 2004.I’ll peg the average valuation of a venture-backed IPO goingforward at $3 billion.The sub $100mm exits I’ll assume at an average of $30million each.What that gives us is the following:Total capital deployed: $10 billionIPO values: 10 x $3 billion = $30 billionM&A values: 50 x $250 million = $12.5 billionSub-$100mm: 250 x $30 million = $7.5 billionFailures: 690 x $0 = $0Total Value: $50 billionSince you’ve assumed a $10mm pre and $20mm post – thatimplies that the average transaction is for $10mm and the VC owns 50%(recognizing that we are again ignoring follow-on financing rounds).This means that Total Value inuring to the VC investor is$25 billion on $10 billion of deployed capital.So that’s what I think many investors are probablyevaluating today. Naturally, if you reduce the assumed size of the IPOvaluation, it will have a significant effect on these calculations (reasonablediscussion might be had as to these likely values, Bill Quigley at Clearstonehas a great presentation on this http://quigleyreport.com/?p…,as well assuming a lower sub-$100mm exit average (or %).Of course, we’ve also ignored the time frame under which this occurs.Curious as to your reaction.Cheers – and as always, thanks for all that you do for thecommunity via AVC and the general approach to transparency that you take!
Interesting analysis. There are two problems for VCs in this scenario. The first is that the 10 (or whatever) IPOs are unevenly distributed and are often clustered with the top firms, so everyone else is f#$%ed from the get-go. The second is that $25B return on $10B over 10 years is a 9% return on investment, before management fees and carry. So then the limited partners are unhappy… and most VCs are f#$%ed. Not a fun game when I think about it that way!
that $3bn is too highotherwise, this is excellent math and a great conclusion
Seems like you also ignored the number of strike outs on capital deployed?
? Think you misread, Bill – the math notes 690 deals that are utter failures (i.e., go to zero).
It is a staggering discovery.It actually shows an incapability of VCs to find out what is a right start-up to fund. Nothing to do with valuations.
Venture Logic:1. I have a fund I’ve raised with a 10 year life and a 5 year commitment period, thus, on average, I have 2.5 years to put the money to work (average across all the funds)2. While there are likely fewer greater than $100M exits, there are likely more sub $100M M&A transactions, thus given my preferences, I won’t get completely wiped out in a sideways situation3. I’m better than averagePeople who invest in my asset class have made the asset allocation decision, it’s just up to me to invest the best I can in the market I find myself in.5. If I sit on my hands, I’ll never invest in the next Facebook and my money will be taken away from me. If I invest, there’s some chance I might find the next Facebook and if I don’t my money might get taken away from me – but 10 years from now.6. Most of these outcomes are binary anyway. sure $5 on $10 is better than $5 on $20, but if I get it to $200M I make a great return either way – so if the alternative is never calling the capital – here’s the termsheet – $5 on $20!7. Outliers are what get people to invest in the first place. If you offer me 20% returns in nameless, faceless, non sexy companies, I’m likely to go elsewhere. I want to talk to people at cocktail parties about my latest $4B IPO.There’s a lot more I could add – suffice it to say – I agree completely with you.Only one solution – find founders who understand the value of a partnership with you, what you can build together – and go in that direction. Either that or sit on your hands.
You know I just realized, it may help a lot of these funds if they changed the method of capital call to a system more similar to what hedge funds use. It may help mitigate some of the faulity logic…
I think intimate relationships are much more important than a money-based relationship.
that’s pretty good logic harrybut when the returns on the binary good outcomes don’t cover the losses on the binary bad outcomes, you are fuckedwe are in that phase in the cycle right now
AgreedI believe we are seeing what behavioral economists call post purchase rationalization.Founders are using all the tricks in the book to get people in and prices up:We are over subscribed ( social proof )We want to close soon ( time sensitivity )We want value added partners ( reciprocation )And why not.But no one says you have to play.
Harry & Fred,I read each of your comments and was wondering about the way you think about your portfolio allocation strategies based on your world beliefs.Fred is saying that he is not currently investing at today’s valuations because his world view is that the market is overheated and that he thinks he can wait.Harry is saying that he has money invested from LPs who have sought his expertise in selecting the best companies in the venture stage asset class at this time period and will continue investing. When it comes to whether or not to invest, Harry feels responsible for allocating the money to new investments since that is what LPs have hired him to do and they need exposure to that asset class as part of the LP’s overall investment strategy.Is this difference in strategy in given today’s market the result of the structure of each of your agreements with LPs, life cycle of your funds, or some other factor?
Just to be clear – my comments are facetious above and are representative of the way I believe many are thinking and rationalizing the current market.I agree with Fred’s philosophy almost completely.So we really are no different (he’s just more successful – but I’m trying to catch up!)Fred is still making investments – as am I – but I think we are both being quite selective in what we are doing, and making sure that the investments we make fit all the criteria we could think of.
we are investing Bill. but carefully as we can
How many of the 85-95% exit below $100mm with a positive outcome?
depends on what positive is but if breaking even is included, then about 50%
What this chart (and yesterday’s) are really saying in a different way is that venture as an asset class has not generated a lot of $100MM+ returns over the trailing 10 year period either through IPO or M&A. We know this already if you look at trailing 10 data on VC asset class performance – see data from NVCA here http://nvca.org/index.php?o… which shows trailing 10 IRR of -4.6%Fred is arguing that early stage valuations are getting higher – and thus exit values needs to be higher on a relative basis to make the math work on capital deployed. So the point is missed when we sit here and argue whether valuations are really higher today or if it’s only in consumer internet deals. The point is that the real data, from the last 10 years, with real deals and real exits (or lack thereof) has led to real returns which are really quite putrid for the asset class. The reason why? there just haven’t been very many total returns of more than 100MM. so unless there is a big increase in total numbers of IPOs or M&A transactions for large amounts (or a few that are gargantuan that will swing the numbers…facebook anyone?) then it’s likely VC returns as an asset class could continue to be less than ideal. And if valuations really are getting pumped up as Fred suggests, it could exacerbate the issue.
I have been on both sides of the table (entrepreneur and board member) for a long time. I now STRONGLY believe in smaller raises at reasonable valuations and keeping value creation closely aligned with fund raising. The companies that raised big rounds on frothy valuations in 2007 had real trouble raising follow on capital in 2009.
I could not agree more. Way too much emphasis is placed on valuations, when the real dynamics are around the terms of “participation”. To summarize, the entrepreneur might get a great valuation, but what exactly did they accomplish when the terms of participation actually claw most value back to the preferred? I would much rather focus on a reasonable valuation along with reasonable terms, and not chase the highest valuation.
You’d have a better purview than I, but it seems like the companies that are getting $20MM premoney valuations have more traction and a better chance at a big outcome. Not shown here are the vast swaths of startups that raised $500K-$1mm in seed financing but are never going to see a VC term sheet. Put differently, higher series A valuations are a natural consequence of teams being able to get further on $1MM seed financing. Plus, things are a little crazy! 😉
Susters post was really superb (as usual.) Likewise, your thinking on these topics is always bracing and honest and helpful. But I think you are both under- appreciating the real issue — there is still way way too much capital in the VC asset class. As an entrepreneur I am delighted when capital is plentiful and cheap. But as an investor — and as a citizen — I can’t help but be dismayed at the evolution of VC investing over the last 10-15 years — from the mission critical fuel injection apparatus of the global economy, to, what? A version of Hollywood?If there was a lot less capital, there would be much more rational valuations, and much more focus on big disruption and big opportunity and big innovation. There would have to be — scarcity of capital would make it imperative that VC investors figure out how to create returns, to survive and prosper. As it is, oversupply of capital allows for VC investors to make too many bets based on too little thinking, while hoping to find the next facebook (the next 1000X return) and be paid huge comp regardless of outcome…Which isn’t to say anyone is a bad person or doing bad things. We’re human beings, too cheap capital has this effect on homo sapiens!But I think it would be good for everybody — everybody — if some big portion of VCs and funds weren’t in the marketplace…
i agree stevewe’ve exercised restraint on our funds sizessome of our colleagues have not
[ Sorry about different sized fonts below – not done by me, maybe by Disqus ].Great comment overall, particularly the first two paragraphs. But I would state one line a bit differently: instead of:”If there was a lot less capital, there would be much more rational valuations, …”,I would say:”If there was more thinking, there would be much more rational valuations, …”The rationality of valuations should not depend on the amount of capital available – and it is not sure that it would be more rational if there was less capital.Also, IMO the focus should not be on disruption per se – though it seems to be happening a lot, witness the use of the term on the net and in confs like TC Disrupt. Disruption may happen as a side-effect, but why aim for it? I think doing so is missing the point. Why not just aim for making something better, or new and good, so that people (including the makers and users) benefit from it?
The rationality of valuations is almost entirely based on the amount of capital. Think about it. Public market valuations, driven by the inflows of dollars into mutual funds looking to be deployed, drive the IPO market. The valuations in today’s IPO markets impact the exit valuation thinking on exits, regardless of and IPO or a sale. And all of these valuation points, as well as the temporary exitement in this part of the cycle, drive up the valuations in the earlier stage cycle, causing the entry point valuations to be driven up too. The unfortunate reality is also no different than the IPO market, which is that an overpriced IPO bites the public markets investor. But the overpriced early stage investor bites both the entrepreneur as well as the VC. The entrepreneur is forced to attempt wacky things to get an exit multiple that works for the VC, while the VC is forced from the over valuation dynamic to also put more pressure on the company to help them get an over priced exit. Rarely do the market cycles coincide from over priced entry, to over priced exit, so someone will go home not happy. This is long winded, and I hope it helps!Moral of the story…over valuation on the entry does nobody any good.
Sorry for slightly late reply.I agree with most / all of what you say. The only thing is, I was not talking (in my comment to which you replied) about things as they are, but as they should (IMO) be. Notice that I used the words “*If* there was more (clear) thinking” and “The rationality of valuations *should* not depend”. On current human behavior as described by you, I totally agree. It’s pretty well known that greed and fear drive the investment decisions of the majority of people (they buy when it’s too late, and sell when it’s too late), driven by above-mentioned emotions – and ignorance, and that’s why we have the ups and downs in the investment markets that we keep seeing over the years / decades. There are other factors, of course, such as market manipulation, but that becomes too long for a blog comment.
Quoting myself:>”On current human behavior””Current”? Sorry – wrong choice of word. Eternal or unchanging or everlasting or never-ending may be better words. Said by a guy who’s not pessimist, BTW, just a realist.
The problem with both of these analyses is the assumption that a 20% IRR should be the norm. This asset class has negative returns in the last 10 years, as pointed out above, and IMO will struggle for 10% returns going forward. I have been on all 3 sides of the fence, as a strategic corporate VC during 1999-2001 at a public tech company (dumb money), as an LP in a $400M tier 2 fund closed in 2001 (more dumb money), and as an entrepreneur that landed a series A term sheet for $6M on $6M pre with 2 other guys and a PPT presentation from a tier 1 VC in 2002, so I get the dynamics. I am also currently raising a seed round for a new venture. Yes, everyone wants to hit a home run, but as an asset class I think the LPs and early stage VCs need to reset return expectations, especially when compared to the risk/return profiles of the other investment options.
these have both been great posts.
Setting aside some issues with the model. I agree valuations are too high. Later they will be too low.That is how markets work. They are not perfect.Maybe VCs need a diversification strategy. Or a way to hedge.
Hi Fred, Right now it appears to me that the shitty entrepreneurs* are screwing the good VC’s, and the shitty VC’s are screwing good entrepreneurs (which isn’t a new trend). I would advise altering your investment thesis to avoid the tech hipster startups. *by “shitty entrepreneurs” I mean, over-hyped, Silicon Valley/Tech Hipsters, little revenue)
We were considering to approach a VC. Thanks for the heads up. Very enlightening statistics.http://www.chrishennation.c…
This is classic inflation. Too many dollars chasing too few goods. In this case, there is a finite number of legit valuable new companies.
Define “legit valuable new companies” – Meaning they’re on tech crunch? Or generating x revenue?
That they have some reasonable expectation of earnings.
Agreed. There seems to be a common wisdom that this time it is different given the growth in usage of the Internet and that it will create better exits in the future than took place in the past. Perhaps the common wisdom is right, but it relies on the future being different than the past.I believe that it is going to get worse before it gets better, but perhaps there will be a shock that deflates this growing bubble or perhaps the common wisdom will be right and lead us into a new world….Scott MaxwellOpenView Venture Partners
Exactly.So what’s the plan for you guys to make money, then?
You lost me on that one. You might want to do a blog explaining that.Meanwhile, the ice tea jugs are down to 2/$5.00 at Gristedes but the price of fruit this summer is through the roof. The guy in the fruit cart at 25th and 1st still has bananas for $1 tho.
Did you get in on this one, Fred?http://gawker.com/5816461/f…Remember when I told you games were the thing a few years back?BTW, you said you’d invest in “everything I hate”http://secondthoughts.typep…I didn’t last long at all on Farmville (after the Sims, offline and offline, it was too frustrating). I lasted slightly longer on Cityville but it was hard bugging friends all the time to level up.
USV is an investor in Zynga.