Venture Capitalists Shift Gears And Focus On Exiting By Acquisition

Saturday, April 22, 2006

Darren Dahl, Inc. Magazine, http://

Better Business & Planning Practices

Abstracted from: Facing The Capital Gap
Inc. Magazine - February 2006, Pgs. 25-27

Changing landscape.
Venture capitalists, known in the late 1990s for investing in smaller startups and taking them public quickly, have become more conservative in their approach. While established companies or those headed by experienced entrepreneurs find capital readily accessible, early-stage companies looking for $250,000 to $5 million struggle to raise money, even while exhibiting solid growth. Experts confirm that venture capitalists seek out less risky deals, and startups struggle to gain attention at a time when private and institutional investors are streaming into VC funds. To put their money to work, venture capitalists choose bigger deals involving more established companies rather than add partners to scout out smaller or newer ones. By one estimate, Darren Dahl reports, most focus on deals in the $10 million to $25 million range, rather than the $1 million to $2 million range so common years ago.

Size matters.
Most VC funds want portfolio companies that can absorb larger sums. In 2005, only 19% of venture capital went to early-stage companies, an amount that represents just one-seventh of what startups raised in 2000. Angel investors are filling some of the gap, but the difference between the floor for a venture capitalist and the ceiling for an angel remains wide. The reasons for the change in preference extend beyond the need to invest large amounts of capital. The number of initial public offerings­once a common exit strategy for small, younger companies­has dwindled, falling from 406 in 2000 to 194 in 2005. Most of the companies that went public in 2005 were larger, older businesses, the average age being 21 years, compared to 10 years in 2000. The author notes that M&A rather than IPO has become the popular exit strategy for younger companies, particularly after eBay acquired Skype for over $3 billion in September 2005. Many investors prefer working toward an acquisition because it is less risky than taking the company public.

A shift in mission.
For venture capitalists, the mission has changed from finding the next great company to finding the next good acquisition candidate. The change may not be a bad one for shareholders and the business, since several studies show that companies with active founders perform better than those run by professional managers. Many venture capitalists now groom portfolio companies for a sale from day one, a practice that­while potentially lucrative for entrepreneurs­could have far-reaching implications. Instead of taking risks, the business owner may instead focus on the safest strategy to achieve a sale. The owner may also find the role more restrictive, because the VC investors will expect a bold entrepreneur to act rationally rather than emotionally and to endure a more bureaucratic culture before exiting in five or six years.

Abstracted from Inc. Magazine,
published by Mansueto Ventures
375 Lexington Avenue, New York, NY 10017

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