The end game.
You’d think founders and investors would want the same thing.
For everybody – founders, investors, early employees – to make a great deal of money.
But when you ask a founder where they see their company in five to 10 years, a certain political correctness takes over.
A Practical Concern
I’m trying to find out whether the founder would prefer selling their company to the highest bidder in a few years’ time or take longer to go for Unicorn status (when a startup is valuated at $1 billion or more).
It’s a very practical question.
Maybe that’s the problem.
For example, when I asked that question to a co-founder of an Internet of Things company last week, I got a straightforward answer.
“We’re shooting to become a billion-dollar company,” he said.
Then he mentioned three young companies in his sector. One was sold for $250 million. Another for $550 million. And the third for $650 million.
But for every straightforward answer I get, I hear 10 equivocations like…
“We’re just concerned about growing our customer base.”
Or – and this one drives me crazy – “Every day we want to do things a little better.”
I’m not on some noble quest to change the world. I’m not on some Greek hero’s journey. This is not some open-ended adventure.
This is business. The business of investing.
Time frames are important to me. As are a company’s short-, medium- and long-range goals.
Not Buying It
I don’t buy it.
Just like I don’t buy it when a professional football or baseball player in his last contract year says he’s not worried about his next contract.
I’m pretty sure he’s thinking about it every day… actually, every minute of every day.
I suspect founders think about the end game a lot. If you think I’m being cynical, then let me be clear: I think founders can be passionate, incredibly dedicated and end game-oriented.
Actually, I think it’s a great combination.
If they’ve developed an amazing technology or product… or they have a loyal customer base… or their brand is well known and highly valued…
Then a buyout is quite feasible.
But perhaps that’s not what the founder wants.
I was having lunch with a founder of an Israeli company a couple of months ago, and I mentioned that he should have plenty of suitors.
He looked me in the eyes and said, “It would have to be an unbelievable offer. I want to run this company for the rest of my life.”
I didn’t invest. I liked this company because I thought a payout could be three years away, not 10.
It was how he felt. And I respected it. But it changed the way I felt. When we parted ways, I wished him the best of luck.
A founder and an investor won’t always see eye to eye on this.
All the more reason you should have an end game in mind.
So here’s a quick tutorial on what IPOs offer versus what buyouts offer…
- The obvious one: It gives you the biggest returns. How big? On average, 36X for seed investors. (See my earlier post here for more details.)
If you want your companies to grow into $1 billion companies, they’ll most likely have to go the IPO route. Some startups do get bought out for $1 billion or more. Oculus Rift was bought by Facebook for $2.3 billion, for example. But only a couple dozen companies can afford to make such big purchases.
- The less obvious one: Startups can sometimes get a higher valuation by going public than by doing another round of fundraising.
- The hidden one: Your gains don’t have to stop with the IPO. The startup’s value can keep on going up once it’s listed on a public stock exchange.
- The obvious one: You can cash out your profit more quickly.Buyouts typically occur in the Series A through C rounds, when a company’s rapid growth makes it particularly attractive and shares are still relatively cheap.Basically, you’re trading less time for less money. In 2014, returns averaged around 10X. Last year, they averaged around 9X, as the mergers and acquisitions chart below shows.
- The less obvious one: You monetize your startup’s success. (This isn’t a given.) A company can go many years in the netherworld of “too expensive for a buyout but not yet ready for an IPO.” Think Uber.
- The hidden one: You avoid the six-month lockup that prevents you from cashing out your shares right away with an IPO. That’s fine if shares are going up. But if they’re going down, it can be frustrating to be stuck on the sidelines as your shares lose value.
Which do I prefer? I decide company by company.
Startups with huge upside – that I think can really grow into billion-dollar companies or much more – are not ones I want to see bought out for $250 million (even if that represents a 10X profit for me).
Those startups – with lower ceilings and/or execution problems – I’d be pleased to see bought out within two to five years.
Sometimes, founders can be too ambitious. Other times, not ambitious enough. Which is why you should always ask about the end game.
I like filling my portfolio with a mix of both, going for monumentally large winners and the less monumental 10X winners.
It’s yet another way to diversify risk.
But the beauty of early investing is that either way, early investors win big.
Invest early and well,
Founder, Early Investing