If You Take Venture Capital, You’re Forcing Your Company To Exit by Luke Kanies

TL;DR - “[A] company has four options: Go broke, go public, get bought, or stay private indefinitely. If you take VC money, that last option is off the table.”

Helpfulness - 4

Topic Tags - incentives, LP, Exit, founder advice, equity

Questions answered:

  • Why do VCs want portfolio companies to exit?

Summary:

  • VCs are funded by LPs, and are bound by contracts to try and maximize earnings for them. VCs take the funds and invest in startups for equity, known as preferred stock.
  • Preferred stock is illiquid, which means that LPs have no use for it until it is liquid.
    • Liquidity points to being acquired or going public with an IPO.
    • If a portfolio company goes public, VCs help liquidize the stocks by selling them on the public market in intervals from 18-24 months to not hurt the stock price by flooding the supply side.
  • This means VCs will push founders to develop their company enough to exit.
    • Possible scenario: Founder develops company to sizable profitability, $1mil/year. VC pushes for further scaling and growth or recommends you to get acquired. If you don’t want to, VCs may try and remove you from power so they can.
  • VCs don’t gain anything from you profiting a healthy amount except that your company’s value goes up. They don’t want dividends.
  • For the industry, only companies that have the chance of going public can get VC funding.
  • Banks provide funding for low-risk companies. VCs provide funding for high-risk high growth companies, but there is no middle ground for funding. Because of this “lot of companies are able to convince themselves, and thus investors, that they could get big enough to go public.”
  • This growth-at-all-costs mentality often crushes companies that get too big too fast.