Fred Wilson recently wrote a highly popular blog post, highlighting the need for an alternative market for venture backed start-ups, as an opportunity to opt for a liquidity event, benefiting the early stage investors and the founding team. In the late 90s, the liquidity event of choice was an IPO, or get acquired by strategic investors. Nowadays, Fred argues, if you don’t get acquired by Google, Microsoft, or Yahoo, there are very limited venues to maximize the value created by these Internet start-ups, and those that were acquired never materialize to the disruptive force that they were initially acquired for. He cited examples of start-ups that were left for dead after being acquired such as Delicious, Dodgeball, Jaiku, and Feedburner. In a video on Yahoo Tech Ticker, Fred argues that creating a private market for pre-public companies would better utilize the mid to later-staged VC firms, that are flush with cash, and have minimal opportunities to invest their capital. By exiting those companies from the early staged VC firms, the founding teams would have an opportunity to cash out some of their shares and diversify, yet stay on with the companies they founded and create additional value from their ventures.
I agree with Fred on many levels, but with the creation of new markets, it increases the opportunity for regulatory involvement, and with the current credit crisis the financial markets are undertaking, it would take quite a bit of time for this idea to gain any traction. I think it would send off a great deal of red flags.
Some of the pros and cons to Fred’s theory from my perspective are:
A new path to liquidity means that it will increase innovation and investment in early stage/seed start-ups. VCs will be encouraged to invest in ideas, which would bode well for entrepreneurs, especially those without the connections and money. A young start-up in Chicago wouldn’t have to waste valuable time hunting down a few dollars to get the business off the ground, instead, they would focus on solving problems, creating value, and expanding their business. Additionally, the founders would have confidence that their companies could have liquidity options, that are founder friendly, similar to some VC firms such as the Founders Fund, which have “FF shares” that enable the entrepreneurs to cash out some of the money, so they can diversify and maybe buy a house, rather than living in the basement of their mother’s apartment (jokingly).
The major con that I can see from this new market is that as with the late 90s, you’ll see a flurry of venture capital thrown into powerpoint presentations, and will encourage everyone and their grandmother to start an Internet company, thus facilitating vaporware, and is not sustainable long-term. And based on our US financial system hanging in the balance, government may have something to say about this, despite the fact that the PE/VC market is highly unregulated in many ways because they are considered sophisticated, accredited investors.
All in all, I think this is a net positive, because, although I am highly biased, these small companies are tackling major problems, and we need forces to encourage innovation, enable entrepreneurs to focus on solving problems, and give them opportunities to cash out some of the shares so they can feed their families. All too often, these start-ups are gobbled up by the big guys and are unable to create value, because they are not integrated into the framework of the acquiring company. This is Pareto sub-optimal and the creation of the market that Fred speaks about, is necessary to prevent the influx of me-too start-ups that are not aiming to be disruptive because it’s much easier getting funding for another video sharing site.