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Venture Capital Basics: Exit Issues
Tim Oren explains in a great post the basics of the venture capital model and how the exit (i.e. the monetization of their investment for the venture capitalists through an IPO, trade sale, or similar arrangement) influences everything: It is the core of the venture capital model, it is a constitutional requirement for the venture capital firm, it is a huge change of control for the portfolio firm. And most importantly, a startup's exit perspectives are the paramount factor for its chances to receive venture capital.
The need to exit is the core of the venture model. You might have a wonderful business idea, that will make its customers, employees, and managers all happy, but if it is unlikely to exit, and with a sufficient return on the capital put in, we don't want it. It could in fact generate wonderful cash flow forever, but if we can't monetize that in a liquid form by the end of the fund, it won't make it through the partners' meeting. It is inherent in the nature of the beast.
Exactly. Quite a few startups don't care for the exit issue or can't build a model that will successfully exit. Just as Tim puts it, that doesn't mean these startups are any worse than other startups -- they're just not fit to the venture capital model. You will often read here and there snickering and bickering about how VCs push their startups beyond the edge and supposedly do not allow them to become "healthily run" companies. This totally misses the point: If a startup management has decided to take venture capital into the company, they have (hopefully knowingly) signed a contract that has the exit as its core purpose. A healthily run company that doesn't exit by definition cannot produce a return for the venture capitalist -- he has to liquidate his fund back to his own investors after about ten years, and everything that is not liquiditable before that is a lost investment. Everybody should be aware of that issue when considering venture capital, and -- also based on my own experience and acquaintances -- not everybody does.