Welcome to the Lost Decade (for Entrepreneurs, IPO’s and VC’s)

If you take funding from a venture capital firm or angel investor and want to build a large, enduring company (rather than sell it to the highest bidder), this isn’t the decade to do it. The collapse of the IPO market and dysfunctional math in the venture capital community has stacked the odds against you.

Here’s why.

The Golden Age for Entrepreneurs and VC’s
The two decades from 1979 when pension funds fueled the expansion of venture capital to 2000 when the dot-com bubble burst were the Golden Age for entrepreneurs and venture capital firms. VC’s were making investments every other financially prudent institution wouldn’t touch – and they were printing money.

The system worked in predictable and profitable ways. VC’s invested their limited partners’ “risk capital” in a portfolio of startups in exchange for illiquid stock. Most of the startups they invested in either died by running out of money before they found a scalable business model or ended up in the “land of the living dead” by never growing (failing to Pivot.)

Startup lifecycle in an IPO Market

But a few startups succeeded and grew into profitable companies. Their venture investors made money by selling their share of these successful companies at a large multiple over what they originally paid for it. One of the ways most predictable ways for an investor to sell these shares was to take a company “public.” (Until 1995 startups going public typically had a track record of revenue and profits. Netscape’s 1995 IPO changed the rules. Suddenly there was a public market for companies with limited revenue and no profit. This was the beginning of the 5-year dot-com bubble.)

During the decade between 1991 and 2000, nearly 2000 venture backed companies went public. Take a look at the chart below. (It includes venture funded startups in all industries, from software to biotech. Source: NVCA.)

Number of Venture Backed Liquidity Events 1991-2000

The size of the red bars (IPO’s) versus blue (mergers and acquisitions) illustrates that while venture-backed startups did get acquired, the IPO market was booming.

Free At Last
Going public did two things for your company. Your company had money in the bank to expand your business, scaling the company from the “build” stage into the “grow” stage. But even more important, your VC’s  could sell off their ownership of your company. This changed their interest from managing your board for their liquidity to managing the board for all shareholders.  Most VC’s would get off of boards of companies that went public.

Success Means That You’re Acquired
The public markets for venture-backed technology stocks never really recovered after the collapse of the dot-com boom. Fast forward to today and take a look at the last ten years of  IPO’s and M&A’s in the chart below, and you’ll see why life is different for entrepreneurs.

Number of Venture Backed Liquidity Events 2000-2010

Depending on your industry, in this decade it’s 5 to 10x less likely that your company will have an IPO as an exit. And what the chart doesn’t show is that the dollar amount of the deals are significantly smaller than the last decade.

Since there’s no public market for the shares your venture investor has bought in your startup, the most reasonable way for a venture firm to make money is to have you sell your company to another company. But unlike an IPO where you sold stock to the public and got to run your company, in an acquisition your company is gone, and the odds are in a year or so you will be too.

Startup Lifecycle Today

VC “Plan B”
None of this has gone unnoticed by the venture community. Some of the old-line venture firms have changed their strategy, but some are still locked into last decade’s model while the partners are living off of their management fees and go through cargo cult like rituals. You can tell who they are by how often they remind you “this is the year the IPO market will come back.” (If the limited partners of these VC’s acted like real fiduciaries rather than waiting for the end of life of the fund, more than half of old-line venture firms would have shut themselves down today.)

New, agile and adroit venture firms with new business models have emerged to deal with the reality that 1) web 2.0 startups require significantly less capital to start, 2) exits for venture firms are predominately acquisitions, and 3) a venture firm with a smaller fund <$150M matches these exits. Floodgate, Greycroft, Union Square Ventures, True Ventures, etc. are example of this class of firm. (Raising a VC fund in this environment had it’s own perils.) And the explosion of private Angel firms continues to fuel this new ecosystem.

Other VC’s who invest in Information Technology have taken a different approach. They’ve created virtual IPO’s for founders and employees via late-stage private financing. It has put a per user dollar value on these sites and these few startups will be the next likely IPO candidates. In their short time as a fund, Andreessen Horowitz seems to be on top of this game with their investments in Facebook, Skype and Zynga.

What About Us?
But not all industries are as capital efficient as the Web or Information Technology. Biotech, medical devices, semiconductors, communications and CleanTech require significantly more capital to build and scale before they can generate profits. It’s in these industries that the lack of a public market has taken the heaviest toll on entrepreneurs and their startups. Great companies with innovative ideas have simply died not having the cash to scale. VC’s who would have normally kept writing checks were faced with no public exits and cut them off.

Some of these industries have turned to the U.S government for funding. Elon Musk has not only tapped the feds for his electric car startup Tesla, but also received hundreds of millions for his space launch company – SpaceX. Other Clean Tech companies have tried this approach as well. Yet while the U.S. government doles out funds to connected entrepreneurs, it lacks an integrated strategy to deal with the lack of public market financing for critical growth industries.

It may be that these entrepreneurial industries suffer the same fate as manufacturing in the U.S.- they die out of benign neglect and a lack of a coherent understanding of the role of risk capital in our national interest.

What Does it Mean to an Entrepreneur?
If you’re starting a software company, your exit is most likely a sale to a larger company. This decade has been a Darwinian filter – only the very best companies will survive as standalone companies.

If you’re starting a company in other, capital intensive industries, it’s no longer just about having great technology. You need a plan for partnership and long term funding from day one.

In either case Customer Development provides entrepreneurs with a methodology for being capital efficient.

We live in interesting times.

Lessons Learned

  • Advice that’s more than 5 years old is obsolete.
  • Software startups are most likely to exit as an acquisition.
  • Being acquired has lots of math challenges about your valuation, amount of money raised, percent of founder ownership, type of investor, etc.
  • Non-software companies need to be thinking much deeper and further than ever before about search, build, grow funding strategies.  It’s no longer just about building great technology.
  • Customer Development provides entrepreneurs with a methodology for being capital efficient to scale when the funding environment demands it.
  • You will probably not survive the acquisition.

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27 Responses

  1. Excellent analysis, Steve. It amazes me how the myth of mean reversion seems to suck so many in. It reminds me of the friend who kept investing more money into Exodus during the dot-com bust by saying, “Hey, the stock was at $80 before, so it must be a screaming buy at $20.”

    The problem is that times change (as your chart of exits so clearly indicates). An absence of exits and a profusion of funding means it’s easy to get into the entrepreneurial game, but hard to get out.

    I predict a much greater emphasis on capital efficiency and quasi-bootstrapping. The problem is that this simply doesn’t work for many industries, and how that problem resolves itself will have major impact on the economy.

  2. Read in conjunction with Andy Grove’s essay on July 1, the picture here is quite bleak. Not enough attention has been paid by the federal government to fixing the blockages to the IPO pipeline. Without that alternative, it’s tough even to negotiate a fair deal with acquirers.

  3. Are times different now, or was the IPO boom the outlier?

    I can’t help but think that, from a responsible investment point of view, the current environment makes a whole lot more sense. Companies _should_ want to get started as cash efficiently as they can, and just showing up isn’t good enough to justify IPO.

    As you point out, Steve, some companies will claw their way into scalable entities that justify publicly traded equity. But, there is nothing magically inherent to a venture backed startup company that makes it a better IPO candidate than a local hardware store. The business model itself has to justify it.

    Matching up cash-in requirements to cash-out requirements just makes sense. Your advice has tremendous value because it points out the economic reality that startup founders and those funding them need to operate under.

    Thanks for such a thoughtful, data-rich post.
    -matt

    • Don’t forget how many of the IPOs in the 90’s were pre-revenue (in Biotech) and/or sub $20m revenues (dot com).

      Many of the IPO exits in the 90s were virtually fraudulent (not really, but you know what I mean).

  4. It’s time to tap international IPO options. The U.S. IPO shutdown occurred simultaneously w/ Sarbox. The U.S. proceeded to lose its international lead in IPO’s.

    Now the U.S. is doing same thing to its V.C. industry with new taxation rules on carry. The same thing that happened to the U.S. international leadership in IPO’s will happen to its expiring leadership role in V.C. this decade.

    This is all a regulatory phenomenon, nothing more, nothing less.

    So the options become: a) accept the current system with the liquidity possibilities mentioned in your article, b) change the system — make small IPO’s feasible again in the U.S., or c) go international.

  5. Shouldn’t the title of the article be “say good bye to” rather than “welcome to” the lost decade? Good to learn from the past. What will the next decade bring?

  6. I’ve read in other places that Sarbanes-Oxley has had a lot do with the decline in IPOs. Some companies have even gone from being public back to being private.

  7. US is in for another lost decade ahead for innovation, as:

    – US venture capital industry is expected to shrink considerably (http://techcrunch.com/2010/07/13/report-u-s-venture-capital-industry-expected-to-shrink-while-emerging-markets-grow/)

    – Immigration brain drain takes place. Only 18,000 applications had been filed for regular H-1Bs so far this year.
    (http://money.cnn.com/2010/06/14/news/economy/immigration_brain_drain.fortune/index.htm)

    – US manufacturing jobs keep slipping away, and the trend will likely continue – Nation’s 100 biggest markets have lost ~40% jobs compared to a decade ago (http://buffalo.bizjournals.com/buffalo/blog/the_score/2010/07/manufacturing_jobs_keep_slipping_away.html)

    We need to act now to reverse these long term trends, otherwise innovation will dissipate rather quickly, as the world braces austerity and the second US recession

  8. The truth of the matter is that there are many scalable new ideas out there but in new markets. In the past, most of these scalable ideas were in new, just created fields. For example, a new market is the combination of personal exercise machine interacting with the gaming industry. The first out that really works has the field to itself. The Wii system is not an exercise machine just a toy.

  9. Randomly I was just speaking with a friend at a fund of funds a couple weeks ago. He was talking about a “lost generation” of VCs who became partners after the crazy times of the 90s. Most of them have yet to make their mark or experience successful exits. They are just living off their management fees and hoping another fund will be closed. And he said surprisingly some of them do even if their last fund or two haven’t returned anything, but they ride on their media love one senior partner’s reputation.

  10. Good post Steve, but I really strongly disagree with your overall premise… My points are as follows regarding IPO’s & Acquisitions:

    IPO’s – You compared different decades and their IPO production ie 1991- 2000 and 2001 – present etc. Well, what about the burgeoning private markets? The liquidity via sharespost.com and secondmarket.com allows companies to raise additional capital and bridge their finances in the private markets, if they are capital efficient and have revenue, why would they force an IPO? I think you missed premise of the IPO to raise money (not just cash-out for investors)…

    Acquisitions – Are going to pick up like crazy! WIth companies like GOOG, AMZN, MSFT, AAPL having millions or even BILLIONS on the book and very little to no debt, they will be consuming startups left and right. Hasn’t it already happened in fact? Each of the previously mentioned companies has made ATLEAST TWO acquisitions… with the low cost of acquisition for growing startups, I think we’ll see the large corporations in the public markets acquiring private startups daily….

    Can’t believe you don’t see this…. Am I being presumptious, or do my premise support my logic?

  11. Interesting post on the day that Smarts does the biggest IPO in Canada in 10 years and the biggest tech IPO in the US this year. Dave and Nancy built a great business – carefully building great products and amazing their customers. Their vision and excitement for their company was the same 15 years ago when I meet them in a strip mall as it is today.

    They had many offers to sell along the way, but wanted to build a great stand alone company….. Maybe we just need fewer quick flip investors and entrepreneurs?

  12. [...] a changing-the-world level (changing-our-world level: yes, that’s entirely different) [1]. “But not all industries are as capital efficient as the Web or Information Technology. Biotech… – Steven [...]

  13. Repealing Sarbox would be the biggest stimulus for the economy right now. It’s too hard and too costly to go public and stay public these days, so there are no small IPOs any more, which means a lot of small companies are capital constrained and can’t grow into large companies (and employ a lot of people in the process).

    • Maybe another way to look at this is the following: The markets for products/services, especially in the software space do no warrant a heavy cost structure and logically, a big company or a huge VC investment. SarbOx is an added cost if you want to go public. But what if you dont have to?

  14. [...] Welcome to the Lost Decade (for Entrepreneurs, IPO’s and VC’s) If you take funding from a venture capital firm or angel investor and want to build a large, enduring company (rather [...] [...]

  15. Wow – wonderful post. Question for you: so clearly you believe the venture market needs to change drastically, but what do you think about statements regarding an angel bubble?

  16. Great article Steve with great points. Here are a few thoughts:

    1. SOX and the regulatory ennvironment have a ton to do with the lack of IPOs. Companies that are doing 50MM in rev simply can’t afford the $2MM in accounting fees associated with being public. You need to be at least $200 MM on your way to $500 MM or you get cooked.
    2. You have to have a product that Institutional investors understand. A lot of people lost a lot of money in the late 90s investing in page views. The 90s were characterized by “we trust you,” the last 10 years was characterized by “we don’t trust you” and with the evolution of how start ups are built around thought processes such as lean the discussion will be able to change from trust me to let me show you.

    RE the Angel bubble … I wonder if this isn’t a factor of there are a lot more little deals, based ideally on testing and pivoting around metric based companies. If this is the case then it seems like this is a more diversified approach and more likely to succeed for the industry as a whole. Fred Wilson wrote a great piece on seed investing last week about the fact that VCs can get in at much lower dollar values with more companies and spread the risk around. That doesn’t seem like a bubble to me.

    The scariest part of the article was the reference to the high tech, long run way innovation sectors that are dying such as space and biotech. We have been way ahead. We, as a society, need to figure out how to fix that.

    Sorry for the long comment.

  17. Steve,

    Thanks for the high level view of what’s happening right not. On a different note, I’m interested to know how come you haven’t pivoted your blog with the services, like Disqus, that allow commenting via a social account.

    @cdstern

  18. [...] There have been two recent articles articulating the details that make the point really well. The first is John Jannarone’s WSJ Heard on the Street article “Venture Capital Should Shrivel Away” and the other Steve Blank’s “Welcome to the Lost Decade (for Entrepreneurs, IPO’s and VC’s).” [...]

  19. Most if not all of your points are very well taken. However, I just like to add that there are still funding opportunities out there – if one is willing to look beyond the pale.

    My company has been able to organize funding through 2 companies inn Europe: SO Ventures (life sciences) and eSolve Capital, which through their eSolveNano division (http://esolvenano.com) offers a very well placed aggregating function for hitech sectors.

  20. [...] The Role of Investor Risk in the Lost Decade for Entrepreneurs 19 Jul Mark Langner tweetcount_url='http://blog.3strides.com/the-role-of-investor-risk-in-the-lost-decade-for-entrepreneurs/&#039;;tweetcount_title='The Role of Investor Risk in the Lost Decade for Entrepreneurs';tweetcount_cnt=0;tweetcount_size='small';Welcome to the Lost Decade (for Entrepreneurs, IPO’s and VC’s) « Steve Blank: [...]

  21. Steve, you present a valuable historical perspective that I’ve never seen presented anywhere else. I lived through the dot-com boom, bust and revival, first as a corporate lawyer at a firm that was pumping out IPOs in the late 1990s, then at a series of consumer Web companies including Excite, MySpace and eHarmony. MySpace was a great candidate for an IPO if there ever was one (and Redpoint placed its bet accordingly), but was snapped up by News Corp. before that could happen. eHarmony is a business that would likely have gone public 5+ years ago under the last decade’s “rules,” yet is still privately held in 2010 notwithstanding years of growth, profitability and household name recognition.

    I’ve read many political screeds blaming Sarbanes-Oxley for the current state of affairs, but in my view, that perspective is wildly exaggerated by those with political axes to grind. Having implemented SOX compliance at a large international public company the year it was enacted (2002), and then seen how it operated at a far smaller public Internet company a couple years later, it’s clear to me that the burden placed on startups is surmountable and relatively modest (compared to, for example, the underwriter’s discount and legal fees involved in an IPO), whereas it’s a much bigger deal for large, complex enterprises with many subsidiaries and foreign operations, etc. SOX alone certainly does not explain the “lost decade” phenomenon you describe.

  22. [...] the “death of the IPO” and the emergence of the “small market M&A” changes Consumer Internet economics. One of [...]

  23. [...] has been what Steve Blank calls the “lost decade” for tech IPOs. So why do I think that 2011 will be the year this changes? There are 5 [...]

  24. [...] Welcome to the Lost Decade (for Entrepreneurs, IPO’s and VC’s) « Steve Blank: [...]

  25. Not every startup has to follow the above route. It could be a self funded company which grows at a slow and steady rate and is profitable. Thing of it as an online version of a brick and mortar SMB.

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