
When Things Don't Work Out - ssclafani
http://www.avc.com/a_vc/2013/03/when-things-dont-work-out.html#
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dmbaggett
Fred Wilson says: _The first is the "slog it out" scenario. This one is in
many ways the most painful. It means that there is a business that can be
built, but it won't be one that makes the VCs much money and because it takes
so much time and money to "slog it out", it doesn't make the entrepreneur much
money either._

This, in a nutshell, explains the problem with uniformly applying the VC model
to all tech startups. Some tech startups -- often the ones involving creation
of substantive new technology with deep intrinsic value -- require many years
of slogging. There's nothing wrong with startups like that as long as there is
a way to fund them to completion. But how to do that?

The problem is that the standard VC model doesn't really fit well for these
startups, because the VCs by necessity have fixed, relatively short time
horizons.

The VC-funded startups that do work well despite involving slogging and deep
innovation generally seem to hit some vein of gold along the way -- e.g.,
Google "discovering" the psychological fact that consumer click-through rates
are vastly higher for search ads than for other online ads, despite initially
targeting enterprise search sales. This "gold strike" propels these companies
to very rapid, hockey-stick growth that funds the vast investment required to
build the new technology. But they seem _a priori_ unpredictable, which is
troubling if you're looking for a repeatable model of success.

At ITA Software we "slogged it out" from ~1997 to 2010 and created $700M of
value for shareholders; in contrast to the typical scenario Fred describes, it
did very well for both entrepreneurs and the VCs (as well as for many of the
employees). But we'd likely have exhausted the patience of our VCs had we
raised money in 1997 rather than in 2006, and come to a rather different end.
(We actually did look into raising from VCs circa 2000, but the terms offered
were so bad we declined.)

Likewise, imagine trying to make what ultimately became Siri with a VC
partner. SRI spent tens of millions of dollars on that project over a very
long period of time. (I remember seeing a talk on it at AAAI in 2007, at which
point it was already pretty mature, and had cost -- if I recall correctly --
$40M, but was still years away from being acquired by Apple.)

To be clear: I'm not saying the VC model is bad; I'm just saying it's not
universally applicable. And I honestly don't know what to tell entrepreneurs
who want to create companies that don't fit the model well, unless they are
already rich enough to self-fund, in which case I ask if I can invest. :)

~~~
digikata
Just to add to your thought, Siri came from SRI Research which describes
itself as: R&D and Solutions for Government and Business SRI International is
an independent, 501(c)(3) nonprofit research institute conducting client-
sponsored research and development for government, industry, foundations, and
other organizations. SRI’s 2012 revenues were approximately $545 million.

<http://www.sri.com/work/timeline/siri> SRI spun off Siri from SRI in 2007 and
Siri was acquired by Apple in 2010.

There are a lot of governmental, or government-associated organizations which
tend to work with a high level of long-term technical depth. Granted, those
organizations generally show less/varying ability to quickly get technologies
out for public use than VCs.

In an ideal world, it would be nice to imagine that these long term
organizations could operate on the downstream income from products benefitting
from their focus. However, I think the typically the closing of that loop is
through the relatively disconnected path of gov't funding: if that
gov't/society benefits, and that organization can claim a link with past
successes, then more gov't funding follows...

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cperciva
This reminds me of PG's article about schlep
(<http://www.paulgraham.com/schlep.html>) and suggests a startup opportunity:
If you can streamline the process of managing an investment in a poorly-
performing company and/or shutting a company down when it fails completely,
there's probably lots of VCs who would love to hand over their stock cheap,
just to get rid of the headaches so they can focus on the investments they
want to focus on.

YC has proven that startup incubators can be phenomenally effective... who
wants to launch the first startup hospice?

~~~
AlexMuir
I would absolutely love to do this. But it's going to be very difficult -
toeing a line between trading while insolvent, keeping suppliers on board, and
trying to recapitalise an unproven business. There are plenty of distressed
investors / turnaround funds out there - they tend to focus on established
businesses and even then often struggle to achieve a positive outcome.

However, I do think there is scope for a sort of holding pool for products
that are acquihired and then shut down. Eg. Posterous would be a good
candidate. Let the staff go to their new homes, but build a team whose
specialist skillset is in taking an already built product, putting it into
stasis and dropping ongoing costs, and then monetising that existing
tech/content/audience/userbase. Perhaps in the hope that some later startup
can use the existing product to build-off in return for equity.

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ritchiea
This seems like the possible outcomes for high profile startups and not
necessarily most startups. I am relatively young (not even 30) and have
already been a part of a startup that died a much quieter death, absent any
fire sales or acqui-hires.

If anything it reinforces how powerful it is to be a high profile company.
Then your company doesn't just die, it either salvages its resources as an
acqui-hire/firesale (which clearly isn't good but it's something) or survives
unglamorously. There are companies out there that cannot say they were
"fortunate" enough for either of those things to occur.

~~~
ctide
Those are the possible outcomes for premier VC funded startups, so, yeah, that
definitely excludes most startups.

~~~
ritchiea
That's exactly my point. I wanted to draw attention to the fact that this is
the floor only if you're USV or somewhere similar. And I understand Fred's
perspective, no one wants to put hard work into something and see it fail to
flourish. Just to say, wow, if you're as successful as USV people see
tremendous value in your investments even when they don't work out. And I
suspect from the tone the post wasn't written with it in mind that for many
people this kind of downside would be a rather fortunate level of downside
risk.

Alternatively maybe the language he's using and what goes unstated is actually
masking serious financial losses. But I think most startup failures actually
result in founders' and investors' time & money up in smoke.

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austenallred
Thanks for writing this, Fred. I'll be honest, I never thought about the
failures from a VC's perspective other than "Oh well, I guess the other wins
will make up for that one." There's a lot of work that goes on behind the
scenes that you would never have heard about if you weren't a part of it,
because it's not sexy enough to put on display (nor is it advantageous to the
company of the VC).

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outside1234
Why is the fire sale better than acqui-hire? (And to be honest, what is the
difference?)

~~~
PakG1
I think he was using them as synonyms. That would explain to me why there's
only one comma there, instead of two commas to make a series of three nouns,
and also subsequently only two further explanatory descriptions.

~~~
fredwilson
yes, i am using them as synonyms. most fire sales are talent driven deals.

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furtivefelon
I am not sure what kind of companies are the "slog it out" type. Which company
can be profitable (I assume) and not grow much in 2 decades? If they are just
cash cows, why can't the VC/entrepreneurs figure out how to reinvest it in
other sectors?

~~~
nedwin
I don't think he means necessarily that they're cash cows.

It sounds like he means that they're profitable enough to keep surviving and
growing somewhat but not to the point where someone wants to acquire the
business.

Due the emotional investment in the business the entrepreneur slogs it out
hoping they'll stumble upon something that will give them the growth curve
they need to get the acquisition / IPO / other exit opportunity.

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zan10
Why is it so negative to slog it out (from a founder perspecitve)? I
understand that the VC is interested only in 'hits', but I can't see what is
wrong with building a stable and profitable (up to 30 year growth) business
from a startup.

~~~
arbuge
One reason is that the slow growth period would have likely created a series
of down-rounds when the company was raising money in its initial years,
massively diluting the initial founders. So even after the company gets
cashflow positive or figures out some other way to stay alive (loans, etc.)
without raising VC money, the entrepreneurs can never make out like bandits
with the stock they've got left, in most realistic exit scenarios.

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jpdoctor
> _So what happens with the other two-thirds? ... Sometimes an entrepreneur
> will take an early exit. ...That's maybe 10% of the total outcomes. So at
> least 50% of the outcomes are not a win for the VC or the entrepreneur_

In the past, VCs used to say about the portfolio: "3 go north, 3 go south, and
4 turn into the living dead."

I think Fred is saying that 3 go north, 5 go south, 1 turns into the living
dead, and then there's another that we just will agree to ignore.

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michaelochurch
Fred: how do you feel about a template that makes it possible for mid-growth
businesses (the 10-30%/year growth companies that aren't speeding to
liquidity) to make returns to investors? Here's a first scratch I drew at that
concept: [http://michaelochurch.wordpress.com/2013/03/26/gervais-
macle...](http://michaelochurch.wordpress.com/2013/03/26/gervais-
macleod-17-building-the-future-and-financing-lifestyle-businesses/)

The idea is that extreme transparency in profit sharing and compensation makes
it possible for the mid-growth businesses to kick back dividends to investors
while still growing-- instead of several years later at a liquidity event that
may never happen. Thus, investors are fairly treated and get to participate,
financially, in a space of business (mid-growth) that's currently underbanked.

The VC ecosystem is pretty abominable, and I don't think it's because VCs are
bad people. They're not. I think it has a lot more to do with the fact that
these red-ocean gambits require huge, fast-growing companies, so it's a
natural oligarchy. It requires businesses to swell to 100+ people before they
have the cultural readiness to grow to that size while maintaining a decent
culture (hence, most turn into cutthroat, horrid messes).

It seems like if we could come up with a structure that enables the financing
of mid-growth businesses-- equity financing for the 10-30%/year growth
companies with less risk of total failure, that could also use their slower
growth to optimize for creative innovation and cultural health-- then everyone
would win.

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derefr
> I have great admiration for the entrepreneurs I have worked with who have
> slogged it out. There is very little upside for them in this scenario.

These two sentences seem contradictory. Why admire an entrepreneurial Don
Quixote?

~~~
RockyMcNuts
It's admirable to make tough choices and try to return as much as possible to
your investors even when the prospects of a big payday are slim; and to keep
trying to change the world and achieve your vision even if it eludes you for a
long time; and to stand by your customers and employees who believe in that
vision.

Less admirable to jump ship from a going concern because there's no rocket
ship payday and let the VC and everyone else try to salvage as much as
possible.

Think about something like Next... was a struggle and had to be scaled back...
Steve Jobs could have just let it go and moved on to the next big thing.

~~~
derefr
A VC makes their money on the few times they win, and it more than makes up
for all the companies that lose completey. Just barely making back their
investment is no better for them than returning nothing at all. (In fact, they
_could_ be putting the money into market securities with risk equal to your
company's likelihood of return, so you have to give them [that same risk
multiplier] * [their original investment] or they _lose money_ , even if you
give a "positive return.")

A VC would much rather give you 1mil five times and have you kill four of
those companies and make a 100x return on the fifth one. Sitting around
forever on the first one trying to eek out a 2x return means you never build
the fifth one, and that's a much lower aggregate return.

