William Quigley, managing director at Clearstone Venture Partners has a guest post up on Techcrunch this morning arguing that The next ten years will be great for founders and VCs. He gives three reasons:
- Companies are going public at much higher valuations (Google $40bn, VMWare $12bn, Facebook forecast say $70bn, compared with Cisco $0.3bn, Amazon $0.4bn, Microsoft $0.7bn, see the chart inset) and therefore pre-IPO investors are capturing a much larger part of the value creation
- Specialist hedge funds have emerged whose understanding of tech markets enable them to value tech companies more highly
- The speed at which companies can grow internationally has massively increased allowing more value to be created in the first years
I agree with the thrust of what William is saying, certainly I believe that the next ten years will be good, largely on the back of the value creation that comes with deepening penetration of the internet, social and mobile, although the comparative IPO value stats are a little misleading. Firstly venture funds and founders generally held stock post IPO and their participation in the value creation of their companies didn’t stop when their companies went public, and secondly these specialist hedge funds are increasingly investing pre-IPO and providing liquidity to VCs and founders at valuations not much higher than the valuations at which Cisco, Amazon and Microsoft went public. That said, founders and earlier stage VCs are definitely doing better, not least because the increased capital efficiency of modern web and software businesses enables entrepreneurs to create more with less.
The interesting thing about the increased value of IPOs has a few implications for the way that venture capital fund managers should think about exit strategy (see here for a primer on VC exit strategies that I wrote last week as part of the 50 Questions series).
- Investing in one of the companies that generates a multi-billion dollar IPO and not exiting early is the key to supersize returns. This works out even if the VC’s stake is pretty small (1% of Facebook would be enough to return most funds). You have seen this strategy playing out at a number of VC firms over the last few years who have piled into the obvious internet winners without their usual minimum stake or control requirements. Note the importance of having confidence and staying with your winners, something we haven’t always been good at in Europe.
- For the companies that don’t have multi-billion dollar IPO potential M&A will be the more common exit, but the range of acquirers will increasingly include still private companies like Facebook, particularly for deals with sub $100m valuations.
- Secondary sales of founder and/or VC stakes to the smart specialist hedge funds that Quigley mentions will be an increasingly important part of the landscape, particularly for companies that have achieved a valuation in the hundreds of millions but have a shot at getting to the billions. Often these will be partial sales allowing the founder/investor to bank some profit whilst continuing to ride the upside.