January 13, 2011
Jeff Bussgang is a terrific VC, and a blogger I enjoy and respect. I had to chuckle a bit yesterday morning, though, as I read his most recent post, Walking Away from Liquidity. In general, I agree w/ the post – as usual, Jeff makes some great points about how to think about when to sell an early-stage company. But in an effort to make the point more personal, he refers to a couple of recent examples where his companies decided not to sell and “walked away” from exit opportunities. In doing so, Jeff alludes to the “VC-like returns” that might have been generated by those transactions. And so he joins the legions of VCs (present company decidedly included) who play that favorite game of obfuscation, Exit Happy Talk.
What are “VC-like returns,” anyway? Does he mean deal returns that might truly carry a fund, like a >10x cash-on-cash deal? Or does he mean the level of returns we expect to deliver across a whole fund, more like 2-3x, cash-on-cash. Knowing how VCs talk about this stuff, I suspect the latter. If that’s the case, then given the realities of how we make money at the fund level, these specific deals sound more likely to have been pretty mediocre outcomes.
In general, if we’re not quite sure how to read a statement about returns when we hear a VC talk about an exit, as in Jeff’s post, then we can be pretty confident that it really wasn’t all that great. I can talk ambiguously about outcomes as well as the next guy – I’ve been heard in this very blog and elsewhere to use the language “very nice” when describing one of my own exit outcomes – a decidedly blasé one. Trust me, when they’re great, we won’t risk you not quite understanding. (Note: I’m not picking on Jeff specifically, and I know nothing about the specifics of the deals he references, so I could be totally wrong in this instance, but the language he used is illustrative of the broader point.)
Note: I had a good exchange with Jeff Bussgang on this over the past couple of days, and he offered me some specifics on the deals (and clarified in his original post, as well). I was clearly out of line in suggesting that the offers were not strong offers – I didn’t know, so I shouldn’t have drawn any conclusions. Turns out that, in fact, they were both in the 5-10x range – good outcomes, indeed. So I owe Jeff and my readers a big mea culpa for singling him out. I wasn’t intending to be critical – just to illustrate a point. And while the point still holds, I need to be, and will be, more thoughtful in the future about how I choose my examples. Congrats on the success of those companies, Jeff – I, too, hope time proves you guys to have been wise for walking away! And thanks for the advice as I work to get my sea legs here at Can I Buy a Vowel.
My point, really, is that people on the other side of the table from us should understand that VCs work very hard to make every exit sound terrific. Entrepreneurs want to know that you’ve been involved with companies that turned to gold. So we spin them gold. LPs love nothing more than receiving checks from us – it’s what they really pay us to do, after all. So we make sure to celebrate every one we send, even if it’s the result of a mediocre deal.
Bottom line. . .don’t believe the hype. VCs are really, really good at inflating perceptions of exits. So if you don’t know for sure, discount your assumptions heavily. Here are a few hints on how to read through the spin:
- Hearing clear statements of cash-on-cash mutiples is the only way to really know how the VCs did. And if it wasn’t a 6-8x cash-on-cash deal, then it really wasn’t something to get crazy excited about unless it was a really fast flip.
- If it’s a private company sold to another private company and no financial details are offered, forgetaboutit.
- If the multiple isn’t disclosed – public or private acquirer – and if the VCs don’t say anything about it, it probably wasn’t a very good deal. Trust me: if it’s even remotely good, the VC will find a way to talk positively about it.
- If you don’t hear words like “extraordinary return,” “grand slam,” “incredible outcome,” etc., then it wasn’t a big win. Even “home run” can’t be trusted – I’ve heard that term used in its literal “four-bagger” sense, by people describing a 4x return. Remember, folks, if our best deals are 4x’s, we’ll have the luxury of not having to waste all that time trying to raise the next fund – we can go straight to updating our LinkedIn profiles.
- Don’t fall into the trap of believing that the relationship between capital raised and exit value tells you much about the actual outcome.
This last point is a particular pet peeve of mine. It confuses the point, and implies that a lot of so-so outcomes were actually real winners.
Take this example from the December 17 edition of VentureWire, about AOL’s acquisition of Pictella. (Disclaimer: I know nothing about the actual details of this transaction)
[Avalon Ventures] was the sole institutional investor, helping the advertising technology company raise $3.5 million. The Wall Street Journal reported the acquisition price to be between $20 million and $30 million, signaling a quick and lucrative return for Avalon, which invested in 2008.
VentureWire is very clear in praising this as a great outcome. “Quick and lucrative.” But all we know is how much the company raised and a range of possible exit outcomes. And if we take that information and apply 1/3 as a relatively standard ownership position for the money in a company of this profile, then a $20MM exit might only represent a 2-3x return, and $30MM likely not better than 3-4x. And while that’s a nice turn on a horserace, in the venture business, it’s nothing to write home about. (But don’t worry, Avalon has plenty to write home about, with a great portfolio – including a big stake in Zynga, and a just closed and way oversubscribed fund IX)
The point is not the specifics of this deal, though – and depending on how it was structured, it may very well have been a fantastic outcome for Avalon. The point is that VentureWire makes no effort to suggest that given that ratio of capital in to exit value it could possibly have been anything other than a great outcome. That’s plain old misleading. And it encourages the widely accepted notion that 3x and 4x deals can be great outcomes for VCs, which they aren’t – a topic worth addressing in another post.
Bottom line? Understand that only a tiny percentage of exits each year drive true venture returns – 8-10x or better (or maybe 5x+, if it’s really fast). There are many, many more deals that are made to sound good. Learn how to sift through the smoke and mirrors and you’ll start to really understand who’s doing well rather than be fooled by doubles masquerading as home runs.