Early Exits Reviews

Vegas Valley Angels advisor, May 2009
Early Exits - Bill Payne

A colleague in Vancouver, Basil Peters, has written a book on Early Exits for angels. At the Angel Capital Association Summit in Atlanta, he used the data from the book to create a new 1/2-day workshop on the same topic. I have read the book and attended the workshop and find his to be a fresh new perspective on angel investing.

Basil’s premise is that the VC model is broken. There are larger and fewer firms resulting in much larger average investments by VCs. Most importantly (and something I had not considered before), because VCs are investing more money per deal (now nearly $25 million per deal in total), they must wait much longer for exits (now 12-15 years). Why? To get a reasonable return on $25 million, they need to build the value of the company to $500 million or more. Considering the market conditions for most of this decade, that takes a long time. What happens along the way? VCs often block exits that would be quite attractive to angels and entrepreneurs, choosing instead to wait for much larger exits (and increasing the risk of failure along the way).

Basil is suggesting that angels think very carefully before funding deals that will require more money than angels can provide in multiple rounds (say, an upper limit of $3-4 million). He warns that the consequence of investing in deals that will eventually require more than $5 million is a long time to exit and increased risk of failure.

Basil also points out that the sweet spot for M&A deals in now about $30 million. Most of M&A deals are being done in the $15 to $40 million range. Exits in this range are very interesting for angels and entrepreneurs�but not necessarily for VCs.

Basil concludes that we angels should focus more energy on "angel-only" deals requiring $500K to $3 million to get to point where the business model is proven and then begin to look for an attractive exit. Along the way, angels can help their portfolio companies get all the funding they need (in this range) and start early helping to tee the company up for exit.

Visit the Vegas Valley Angels’ website

StartupCFO, June 2, 2009
Early Exits - Mark MacLeod

Excerpt: "Back in January, I wrote about the oncoming era of the "small exit". I felt then (and still do) that the combination of capital efficiency, the bad fit between traditional VC and today’s young startups, the sheer number of startups vs. amount of available capital (especially here in Canada) all pointed towards small exits. Vancouver-based Basil Peters has written a book on this topic which I recently had the pleasure of reading.

Basil lays out a compelling case for early exits. We all know that taking VC is no guarantee of success. In fact, Basil has shown that VC-backed companies have considerably longer time to exit and lower rates of success. There is no question, that his message is anti-VC. And since this comes from a former VC, we should take note."

Read the rest on Mark's website, StartupCFO.ca

EDA Graffiti, June 1, 2009
Early Exits - Paul McLellan

Excerpt: "I came across the book Early Exits recently. It is definitely worth a read, especially for anyone having anything to do with EDA startups. An early exit is one after a relatively small number of years at a relatively small multiple to the original investment. As I discussed earlier, VCs don’t like this sort of deal in general. They need big returns on at least a few of their investments and they don’t care that much about the rest. Early exits don’t interest them."

Read the rest on Paul’s blog, EDA Graffiti

"Early Exits" � a UK academic’s perspective, July 3, 2009
Colin Mason
Hunter Centre for Entrepreneurship, University of Strathclyde, Glasgow, Scotland.
colin.mason@strath.ac.uk

"I have been involved in studying and observing the angel investment market for some 20 years. In recent years I have observed what I call the bifurcation of the venture capital market (bifurcation = to fork into two branches, for example, rivers) in which angels and venture capital funds are increasingly operating in separate markets. This bifurcation has been driven by two key developments. The first is the breakdown of the ‘relay race model’ of investing, described by Benjamin and Margulis in their book Finding Your Wings: How to Locate Private Investors to Fund Your Business (1996, Wiley) as follows: "angel investment runs the critical first leg of the race, passing the baton to [the] venture capital [fund] only after the company has begun to find its stride." Others have preferred a baseball metaphor, seeing angel investors as the farm team for venture capital funds � the major league investors. This development has largely arisen because VCs have raised their minimum investment threshold and reduced their commitment to making early stage investments.

The second development, which is partly related to the first, has been the emergence of angel groups. Individual angels have found it advantageous to work together, notably in terms of better deal flow, opportunities for diversification, superior evaluation and due diligence of investment opportunities. And by aggregating the investment capacity of individual high net worth individuals angel groups are able to make larger investments and follow-on investments to avoid dilution.

Basil Peters’ book Early Exits adds an important third strand to the bifurcation story. His argument is that it costs less to start a technology company so they can be financed by angels, and can achieve an exit within a few years of start-up so follow-on finance from VCs is not needed hence the initial angel investors are not at risk of being diluted. Peters develops this second point at length. Because VCs are investing more in each company this drives up the returns needed from successful investments to generate an acceptable return for the fund as a whole. The consequence is that VCs need to wait longer before they seek an exit, which adds to the risk and reduces the chance of success. One implication is that they may block an exit opportunity that generates an acceptable return for an angel as they strive for a ‘home run’. This behavior is likely to discourage angels from investing in companies that are likely to need a VC round of finance. A further implication for angel investors, which Peters discusses in the second part of the book, is the need to give much more emphasis to exit planning. This discussion complements the writings of Australian entrepreneur, academic and consultant, Tom McKaskill who has written extensively on ‘the art of the exit’ (www.tommckaskill.com).

Peters tells a coherent story. It resonates with what I read and hear from investors. It is consistent with other trends in the VC market. It should be essential reading not just for all angels but also those involved in policy and practice (e.g. university technology transfer offices, economic development officers).

But I do have one caveat. How widely applicable is Peters’ early exits thesis? How relevant is it beyond the Web 2.0 economy? Does it apply to life sciences or clean technology for example? And how relevant is it beyond Silicon Valley? A critical part of the process of early exits is the presence of large technology companies with ‘buy to build’ strategies which spend more on buying small innovative companies than on internal R&D. A cursory reading of the VC media identifies frequent reports of small companies being gobbled up by Microsoft, Cisco, Google, Yahoo! and the like � all Silicon Valley-based. But geography matters! Will young technology companies located at distance from Silicon Valley appear on the radar screens of these large acquisitive businesses? If they are, will their location reduce their attractiveness as acquisition opportunities? And, if such companies are acquired, then what are the economic development implications? Will their IP and know-how simply be uprooted and transferred to Silicon Valley, leaving nothing behind in the locality, region and country in which they were spawned?"

Biographical details
Colin Mason is Professor of Entrepreneurship in the Hunter Centre for Entrepreneurship at the University of Strathclyde in Glasgow, Scotland. His research and teaching are in the area of entrepreneurship and regional development. His specific research is concerned with venture capital and regional development and with the availability of venture capital for entrepreneurial businesses. He has written extensively on business angel investing and has been closely involved with government and private sector initiatives to promote informal venture capital, both in the UK and elsewhere. He is the founding editor of the journal Venture Capital: An International Journal of Entrepreneurial Finance (published by Taylor and Francis Ltd) and a Consulting Editor for the International Small Business Journal (Sage).

Some of his recent papers can be found on the Hunter Centre’s Working Papers page: http://www.strath.ac.uk/huntercentre/research/wp/