Venture Capital and Entrepreneurial Success – The Exit Funnel and You

Every entrepreneur loves their baby and thinks their idea is the next big thing. However, facts don’t lie. Reviewing the venture capital exit funnel from 1991 to 2000 reveals the harsh reality for startups and the challenges for venture capitalists.

There is a delay in performance information for startups, since it can takes three to seven years to determine success or failure. The National Venture Capital Association’s Venture Impact study highlights the winners and losers between 1991 and 2000. Of 11,686 companies founded, only 1,636 (14{1cc8e45cbcdeae64cb989adba369b6a3f691ff03978596e6760cecf20fed8ab4}) had an Initial Public Offering (IPO). Another, 3,856 (33{1cc8e45cbcdeae64cb989adba369b6a3f691ff03978596e6760cecf20fed8ab4}) were acquired. Combined there were 5,492 (47{1cc8e45cbcdeae64cb989adba369b6a3f691ff03978596e6760cecf20fed8ab4}) startup companies that had positive exits. Of the remainder, 2,103 (18{1cc8e45cbcdeae64cb989adba369b6a3f691ff03978596e6760cecf20fed8ab4}) were outright failures and 4,090 (35{1cc8e45cbcdeae64cb989adba369b6a3f691ff03978596e6760cecf20fed8ab4}) are presumed “walking dead”. The “walking dead” or “bobbers” are the startup companies that haven’t failed outright, but have never made enough revenue to break loose. For the majority, it is just a matter of time before the doors close. Therefore, winners to losers are 47{1cc8e45cbcdeae64cb989adba369b6a3f691ff03978596e6760cecf20fed8ab4} to 53{1cc8e45cbcdeae64cb989adba369b6a3f691ff03978596e6760cecf20fed8ab4}. Ironically, it is the same odds as betting “black” on the roulette table in Vegas (to stave off tons of emails -remember that there are two greens on the table, too).

Unfortunately, there is little detailed information on why startups succeed or fail. They are much harder to analyze than public companies whose information is by definition pubic. The successful founders typically have stories, but not complete ones. The failed founders are relatively reticent.

So, how does a startup get into the successful 47{1cc8e45cbcdeae64cb989adba369b6a3f691ff03978596e6760cecf20fed8ab4}? A team that can work together under stressful conditions and has a breadth of skills from engineering to business is the most cited criterion in successful startup stories. Quality capital is another. Having a good top tier venture capitalist that knows the landscape, understands the business and can make introductions is critical. These introductions often provide the catalytic nudge to propel a company forward and past the competition (if your product works). Obtaining capital from friends and family for my first startup was an exercise in absolute frustration, as I spent a large amount of time on calls explaining the business and its fundamentals, as well as chatting about when they would get their money back. My advice is get smart, quality capital. Competition is another big challenge. Competing with other startups can drive the business to new heights and help build a new market. However if Microsoft, Oracle, Dell, Apple, Cisco, Intel or other 800 lb. gorilla has made your strategic vision their corporate goal, a startup cannot compete; get acquired or find another niche. As a rule of thumb, it takes ten times the capital to compete against an entrenched player. Spending a little on stock options to retain quality advisors is also a common theme in success stories. Being able to bounce ideas off someone that has been there and been successful is worth every last stock option. Startups need to make sure advisors will be available for calls and meetings, but don’t expect them to run the company. Building out a startup’s war chest of capital, talent, and advisors yields significant benefits over those that don’t.

The category which entrepreneurs never want to be classified as is the “walking dead” or “bobbers”. So, how do you tell if you are “bobber”? Being objective is a good start. Personally, they are the most demoralizing companies with which to meet. After being retained for acquisition due diligence in 2007, I meet with a couple dozen startup that were founded in 1999 through 2004 throughout the US. Most were struggling along and bringing in some revenue, but it was enough to barely meet expenses. Most did not have the capital to fuel R&D, much less expansion. Like a swimmer on the growing waves of an ocean storm, the companies were just barely keeping their metaphorical head above the water…just bobbing up for a quick breath then down again. With five to seven years of their lives tied up in their startup, the founders would pitch their companies with such passion and conviction, but the stress and strain of the years weigh on them, like an anchor. You could see the desperation in their eyes and hear the quiver in their voices, as they tentatively asked about next steps. They knew that their technology was becoming outdated and there was nothing that they could do about it. Since their original venture capitalists’ funds were timing out after seven to ten years, most were in a race to obtain new all venture capitalist, get acquired, or simply close the doors. Without cash flow to fuel development and growth, technology companies atrophy and slowly die. Succeeding or failing early is a godsend; languishing year after year without either is pure hell. If this description resonates, the startup is a “bobber”.

Although every entrepreneurs’ idea is the next big thing and they all love the baby, the facts are that 53{1cc8e45cbcdeae64cb989adba369b6a3f691ff03978596e6760cecf20fed8ab4} of all startup fail. Venture capitalists know this fact and are thinking about it from the second an entrepreneur sits down with them. They also know that capital is only one aspect of a startup’s success. To improve the odds, entrepreneurs must have assembled a strong team, done their market homework and thought through the business, not just their idea.