VCs are cleaning out their portfolios right now. It seems like there are 3 drivers and 3 methods to doing so. Implications are discussed.
WHY ARE VCS CLEANING OUT THEIR PORTFOLIOS?
- Some companies should get the plug pulled on them. Silicon Valley is built off of a fail fast mentality and the constant birth and death of startups. There are some investments that have underperformed, misexecuted, or been hit hard by the current environment and can not raise cash and are getting shut down.
- The downturn is an opportunity to write off companies with a long time horizon and large capital needs. Some VCs are using the recession and removal of companies that "should die" to also force exits or write offs of investments that may do OK longer term, but are either (a) not on a ridiculous growth curve or (b) require large amounts of additional capital to keep going. I think the thinking is: (i) we can free up partner time to invest in all the high growth startups on a ridiculous growth curve that we can get into cheaply today - so why back a company with only so-so prospects for the forseeable future? and (ii) with the broader cleanse of our portfolio, we can use the recession as "air cover" with our LPs for shutting down or getting out of this company, so it is an easy exit for us and frees up time as per (i) so we can find something that is more of a "sure bet".
- They need to return their funds and please LPs, so they will force exits. The last 2 weeks have seen a slate of exits. Exits are driven by (a) inability by the company to raise capital (so an exit is a better alternative) (b) VCs want to show strength or return capital to LPs so they may force exists (especially if they are raising money or negotiating terms with their LPs for their fund) (c) larger companies may be opportunistics about low startup valuations (especially if their stock is doing well) and buy out startups who think a safe home may be a better alternative then the extra hard work of navigating a recession or (d) traditional M&A logic - sum greater then the parts, the acquirier is giving a good offer, etc. etc.
HOW ARE VCS EXITING?
- Shutting down / liquidating a company.
- M&A - selling (often) at a lower price then the last round
- Wiping the cap table. Having a company go through a down round without the original VC participating, allowing the VC to leave the board although with loss of any future ownership in the company.
SOME RECENT EXAMPLES:
(I have zero inside knowledge of any of these, so my classification of these companies is PURELY 100% speculative and in some cases baded on rumors or e.g. TechCrunch or other blogs):
-Mochi Media (rumors), Zappos: recent press suggested entrepreneurs and investors may have disagreed on exit paths where investors may have been more eager to sell.
-SearchMe: company significantly downsizing/repositioning due to large amount of add-on capital needed.
-iMeem: Cap table wiped, new money raised.
-Xoopit, Zappos (again): Exit into synergistic company with good product fit.
- A lot of startups are going to shut down in the next 6 months. As VCs clean out their portfolios further, a lot of companies are going to go out of business.
- VCs are going to have a lot more time to do new deals in Q1/Q2 2010. With less partner time going to struggling companies, VCs will be able to buy into all the cheap deals they have been seeing lately. This means getting funded for new startups may be easier in early 2010.
- There may be cheap assets to buy. Following the last downturn, there were a number of assets that people bought on the cheap and turned in businesses worth 10s of millions or more. For example, eHow was a site that generated a large amount of content during the last bubble which was then sold for peanuts and reborn as a new version of the original site and eventually sold to Demand Media. You can read about it on wikipedia.
So what do you think? What other companies will be affected by the VC psychology above?
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