Buyers don’t like making VCs rich
Strategic buyers have a funny relationship with VCs. On the one hand, there is often a close relationship. VCs by nature are connected. The best investors spend a lot of time building deep relationships with buyers. Not just with corp dev teams but with the product and business owners that could ultimately sponsor an acquisition.
These connections are built not just with a sale in mind, but rather to help you grow by fostering partnerships and channels. If those relationships turn into acquisition discussions down the road, great!
However, when it comes time to actually buy a company, buyers are thinking about two things: i.) the value they will gain; and ii.) the incentives that the founders and staff will have to stay and create that value.
From a buyer’s perspective, 100% of the value in an acquisition will be created AFTER the deal closes. Buyers absolutely realize that the target company would not have gotten here without the capital provided by it’s investors. But, the investors are just not relevant once the deal closes.
What this means is that buyers only pay big premiums for the few truly exceptional companies; the breakout ones that will have multiple buyers. The ones that have investors beating down their doors to put more cash in. These are the rare companies that can generate the massive returns that VCs are looking for.
The vast majority of acquisition activity is concentrated in what I call “bread and butter” deals. Deals that may be profitable for the founders but often are not. Deals that typically don’t justify the capital invested.
VCs always have preferences in their deal structures. On an exit, they get paid first. But investors all realize that nobody “wins” unless the founders win. This means that any deal where the VCs are just taking their preference rather than converting to common shares along the founders is a bad deal.
There is a simple lesson in all of this, which is easy to say and hard to do: Don’t over-capitalize your business.
There is so much capital swimming around at every stage from seed VCs to PE (especially PE!). It can be so tempting to raise more capital than you need. To be clear, those breakout home run wins will require capital and lots of it! But, hold off on raising it until two conditions exist: i.) You’re 100% committed to going for that home run; and ii.) That commitment is not just based on hope. Rather, it’s based on you having built a repeatable growth machine and having the team in place to make that growth happen.
If you follow this discipline then whether you exit early or go all the way, you will maximize the chances of both you and your investors making money.
