The Path To Exit

How do you get an exit?  A lot of the startup blogosphere talks about getting into a startup.  But, at some point you have to get out.

Personally, I am very dismayed about the length of time companies are staying private today.  Having billion dollar companies sitting quietly in the portfolio’s of venture capital firms doesn’t do anyone any good.  They should be public.

This is a big problem with ancillary effects which are insidious.  They aren’t easy to see.  Long term, they can be dangerous.

Many in the US worry about income inequality and the wealth gap.  I don’t hear the same voices talking about the difficulty it is to go public.  If a person would have bought 100 shares of the IPO of Microsoft and held it untouched to today the investment would be worth $750,000.  The initial investment would have been $2100.

The IRS prohibits unaccredited investors from investing in startup companies.  That might be changing with crowdsourcing which I support.  But, there is nothing like the security of investing in a public offering that has been through the necessary steps.

Having less IPOs hurts pension funds.  It hurts unions.  It hurts employees of the firms.  It hurts the founders and it hurts the venture capitalists.  Put plainly, it hurts people.

Since 2000, the technology of our exchanges has progressed tremendously.  It’s possible to have liquid markets in all kinds of stocks.  The lack of IPO problem isn’t technological.

For those that don’t know the murky world of money, there is a hierarchy when it comes to money in venture funds.  When a VC goes out and gets money for a fund, they talk to high net worth individuals, family offices, and they talk to Fund of Funds.

Fund of funds manage money for very large pools of capital that often come from pensions or endowments.  For example, say I was a teacher’s union pension.  I might allocate a bunch of money to several fund of fund managers.  Those managers represent and are responsible for the future financial health of the teachers.   It’s not a trivial job when you really consider the gravity of it.

The lack of IPOs makes the fund of funds manager job difficult.  They are tasked with getting a nice rate of return for their customers.  No IPO, no return.

Outside of IPOs, what are other paths to exit?

  1. Private equity
  2. Corporate
  3. Family office
  4. Larger startup

But, with the IPO window closed, it makes the competition for startups tamer. This decreases the price by a small factor. Out of the four options I outlined, each is a niche.  Not every private equity firm will be interested in the startup.  You have to find one that specializes in the startups area of business.  A PE exit may or may not be good for the founders and employees of the firm.

Corporate buyers are nice.  They are the biggest part of the exit market.  Again, you have to find the right kind of company to buy that startup.  It also helps if the investors have built a relationship with different target companies to whet their appetite.  Depending on your business, there may be only a few buyers.

Family offices will buy startups if they are cash flow positive and can return capital to them.  However, most startups are not in this position!  This is a small slice of the market.

I have seen larger startups buy smaller startups.  It’s for market share, for a pivot, or for some other strategic reason. That usually results in swapping one form of stock for another.  Again, that doesn’t get anyone liquidity in the chain of fund of funds, venture capitalist, founder, or employee.

Having the ability to IPO will also create more competition in the American economy.  For example, my friend sold his company to PayPal.  He got a good price.  Imagine if an IPO would have been a legitimate option.  Instead of selling to PayPal, the company might have had access to fresh capital and competed with PayPal.

This IPO problem is not easily solved.  In some respects, it’s a public policy problem.  The good news about that is it doesn’t split parties.  Both political parties benefit from having a healthy IPO pipeline.  Heck, more money for donations!

Another major piece of the puzzle is 0% interest rates.  When there is no cost to money there are unintended consequences.  As anyone that has taken Econ 101 knows, for every cost there is an opportunity cost.  The central bankers that have held rates at 0% or negative have done some big time damage to some parts of the economy.  Even if public policy was perfect, many venture backed companies would choose to stay private because the private cost of money was cheaper than the public cost of money.

O% interest rates have slowed the velocity of money.  Cash is sitting on corporate balance sheets.  Bad corporate tax policy also has played a big role.  Corporates are not investing and that is slowing the economy down.  We see it in anemic GDP numbers that never are above 2%.  That’s bad for America and creates income disparity.  No job creation means no source of income.

As startup companies raise capital at higher valuations, they sit on VC balance sheets.  That creates incentives at the seed level for firms to move slower.  How are they ever going to get out of this thing?  Less seed investing means less bites at the apple for new innovation.  That’s bad for America too.  We need innovation to make our lives better and to create jobs.

If we expand the universe of startup companies that could go public from $1B+ to $200M+, there is a huge amount of dead weight loss in the IPO market.  Most venture backed companies do not IPO.  But, the ones that do can create great wealth for the broader based American public.  This is an important issue to fix.


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