Question: You often hear to leave out the possible exit scenario when you pitch. Brad states that its because its usually wrong. I suspect most VC’s discuss likely exits with their partners before making an investment, what percent of the time do you guys generally "guess" the exit on the front side of the investment?
A: (Brad): I’m going to answer this from an early stage VC perspective. I’ve never been a later stage VC nor have I been a buyout guy, so I won’t try to answer for people doing those types of investments.
Back in prehistoric times when there was a tech IPO market, early stage VC’s used to want entrepreneurs to answer the question "Is your companies destined to exit via M&A or an IPO." I’ve always thought this was a stupid question, as the answer is "I’ll take either one!" As homo sapiens evolved, the argument about M&A or IPO raged on fiercely. Pre-Internet bubble, many VC firms (including mine) would often do extensive exit analyses upon each investment round, building complex models stacked on top of detailed assumptions about the future performance of the company, the future multiples in the market, and a range of execution of the company from "flawless" to "pretty good." These analyses usually had an IRR result and a cash on cash return result for each potential outcome.
Almost all of these analyses are total baloney. I suppose they give some people comfort that they basing their investment decision on sound economic analysis, but since there are so many variables that are outside anyone’s control, they tend to be meaningless. In addition, almost all of these analyses (at least the ones I’ve been exposed to, including many from other VC firms), have incredible bias in their assumptions which help support either (a) an affirmative decision to make the investment or (b) a justification for a particular valuation range.
In 2001, the IPO vs. M&A debate cooled for a while when the IPO market vaporized. It emerged again briefly in 2004 and 2005 with a new wave of IPOs, but almost anyone that had an exit in the 2004 – 2007 time frame preferred cash from an M&A transaction to IPO stock (with a few notable exceptions, such as Google.)
VCs fantasize about the day a vibrant small and mid-cap tech IPO market will once again exist. Let’s hope this fantasy becomes a reality. In the mean time, I expect more and more people – especially if they’ve read Nicholas Taleb’s Fooled By Randomness and The Black Swan – will realize that making early stage VC investment decisions based on complex forecasting exercises is – well – foolish.
