There is a lot of press and buzz going around about the rise of the capital efficient start-up. These companies do not need venture capital and hence are free to grow their businesses unencumbered by some Stanford MBA, Mensa venture partner. Ironically, I am moderating a TiE panel this Thursday called "Capital Efficiency for Growing Businesses" (<- click here to register…self-promote!).
Other than control, another reason most entrepreneurs should consider bootstrapping or other non-VC approaches is the trend regarding exits. Historically, 20-30% of VC backed companies went public. Now it is less than 10%. This means that the wins are smaller and it is more difficult to get the VC capital the returns they seek (plus VC’s are raising larger funds and yet again, pumping $10-20m chunks of capital into companies).
Last year, there were only 56 IPO’s of venture backed companies in the US market, down from 93 in 2004 and only 10 IPO’s in the 4th quarter. As of March, there were only 25 companies in registration.
Additionally, more and more bankers and firms are talking about listing on the AIM (Alternative Investment Market) which is the Nasdaq of Europe. Due to the cost and regulatory complexity created for small firms by SOX, the US is losing its position at the heart of the capital market. This is driving IPO values down, and with it, M&A valuations as well. Without the IPO stalking horse, acquirers have less pressure to pay up.
Larger funds are starting to come back into vogue. Many funds cut their size from $800m-$1B to around $400m. Now they are back with $650-700m vehicles. Since the average IPO has hovered around a $180m valuation, it is nearly impossible for a fund to generate 10x on these wins if they have pumped $20m into the deal (unless the average pre-$ was -$2m). This will drive returns down on larger funds that continue to drive larger sums into portfolio companies.
This will be a mess eventually. Avoid it or take smaller amounts of capital ($3-7m). As Seinfeld famously stated: "Become master of your own domain…"