Peter Rip’s Venture Capital Sure Seems Broken – It’s About Time is the latest in a whole series of introspective pieces from VC’s on what’s wrong with their industry. For entrepreneurs, there’s a very valuable lesson in this post. High valuations can work to your disadvantage. As I have written previously, planning for an early exit is smart planning. Peter writes:
Lots of cheap capital, available at high valuations seems great, until you do the exit math. Raise $8M at $12M pre-money and your post-money valuation is $20M. Your investors want to sell for $200M. Raise $2M at $4M pre- and your investors get the same rate of return at $60M. But a $60M exit is 10X more likely than $200M. Few VCs will write the $2M check these days, precisely because a $20M return doesn’t move the needle in a $500M fund. That’s why valuations are moving up – the need to invest more money – not the intrinsic value of startups. Higher valuations and high venture rounds may feel good in the short term, but with IPOs as scarce as they are, they can price you out of the very exit you seek.
Interestingly enough, I had the same conversation over lunch with August Capital EIR Mike Maples last week at ETel. Mike’s point of view (shared by Peter in his post) is that entrepreneurs need to plan for multiple exit strategies, and take the best that presents itself first. A closely held pre-VC company can be sold for a small amount of money, but the instant even a small amount of VC capital is invested, the business plan changes.