How often do series C startups fail to exit?

post by Jessica Shu (jessica-shu) · 2020-09-21T19:37:33.671Z · score: 16 (5 votes) · LW · GW · 6 comments

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  Answers
    11 Dagon
    9 mr-hire
    7 Marc Randolph
    3 deluks917
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6 comments

How often do series C startups really fail? By fail I mean never have an acquisition or IPO. Internet says 80% (see https://medium.com/journal-of-empirical-entrepreneurship/dissecting-startup-failure-by-stage-34bb70354a36) but this seems very high to me.

Most Series C companies are worth in the 100-200M range, the one I'm at is worth 270M. How does all the value just evaporate? What happens to the companies that "fail"?

Asking to decide whether to exercise my options. I only need my company to exit at 41M to break even. I am bearish on the company but with around 40M in ARR it is hard to imagine it not exiting.

Answers

answer by Dagon · 2020-09-23T18:54:07.661Z · score: 11 (6 votes) · LW(p) · GW(p)

Believe the internet.  Most really do fail, and return little or nothing to restricted share- or option-holders, who couldn't sell early as part of other funding deals.

How does all the value just evaporate? 

The problem is that the company is trying to grow, and will increase it's ARR by an order of magnitude in pursuit of that growth.  If they don't actually find a sustainable market, that won't justify an IPO or forward-looking exit.  And then, when the valuation starts to fall, it becomes VERY unattractive to any buyer, who thinks "what am I really getting for this, and why not just wait until it's zero and pick up the remains from the bankruptcy court"?  

comment by mr-hire · 2020-09-29T00:27:10.358Z · score: 2 (1 votes) · LW(p) · GW(p)

The problem is that the company is trying to grow, and will increase it's ARR by an order of magnitude in pursuit of that growth.

 

I got confused reading this a few times, because increasing your annual recurring revenue by an order of magnitude IS growth (most of the time).

I think this is supposed to say something like increasing burn rate by an order of magnitude.

comment by Dagon · 2020-09-29T14:36:04.588Z · score: 3 (2 votes) · LW(p) · GW(p)

Gah, I thought ARR was Annual Run Rate (Burn Rate), not Revenue.  I meant to say they'll use their newfound capital much faster than they increase revenue (which they should!  that's the whole point of seeking funding).  And then, for most, the revenue won't actually increase enough and they go bankrupt.  

My main point was that when it turns, it turns completely.  Every funding source is projecting the future, not looking at the current situation.  A negative direction is zero-value.

answer by mr-hire · 2020-09-21T21:14:19.586Z · score: 9 (5 votes) · LW(p) · GW(p)

Most Series C companies are worth in the 100-200M range, the one I'm at is worth 270M. How does all the value just evaporate? What happens to the companies that "fail"?

 

There's no way to short series C startups, and the market is not open.  It's not an efficient market, so I wouldn't equivocate "VC's valuing the company at X" with "The company being worth X". Recall that most funds don't make money.

Even if it was an efficient market, you have to remember that VCs are black swan farming.  So they're investing in a whole bunch of companies at a valuation $x00,000,000, with the expectation that many of those will go to 0 or be lower than their valuation, in order to get their few unicorns.

comment by ChristianKl · 2020-09-22T14:17:05.288Z · score: 2 (1 votes) · LW(p) · GW(p)

Another difference beween "company is valued at X at a round" and "company is worth X" is that the valuation is effected by other terms of the deal as well. 

answer by Marc Randolph · 2020-09-21T23:53:18.855Z · score: 7 (3 votes) · LW(p) · GW(p)

I vaguely recall that the first startup I was at made it to series D. Or maybe it was just C. Either way, it was around $200M, and we ended up going bankrupt, which I attribute to a couple different things: (1) the market that the exec's and board were targeting didn't really develop fully - although it was probably large enough to support our small company. Which brings me to... (2) the large customers that would have bought enough to support us didn't want to buy from a small company - they bought from more established companies, even if our product was more aggressively priced and better in every way. Which leads to the ultimate reason: (3) early on, the exec's/board didn't accept a buyout from one of those more established companies.

The assets were bought by a second start-up, which I believe did get its own series D, and maybe even E. The problem was they were in the same line of business and could see that the market wasn't expanding (sales basically flat year to year and we flirted with profitability) - so they bought a third startup that was actually in a growing market but struggling financially (partially due to mis-management, I believe). This combination was going to be the key to an IPO... except that the financial crisis happened around the time. Now we were a company where sales weren't growing fast enough to support the burn rate - so the combined company ended up getting sold to an established company for well less than the invested value. I was lucky and happy to basically get my money out of the shares that I exercised at the second start-up.

So as you can see, there are lots of ways the company might not "exit": greed, market doesn't develop as planned (or dries up more quickly than anticipated), exit options become unavailable (for whatever reason), exit timing becomes sub-optimal. If each of those can be discounted with high confidence, then maybe I'd consider investing.

comment by Jessica Shu (jessica-shu) · 2020-09-23T04:15:38.930Z · score: 1 (1 votes) · LW(p) · GW(p)

great answer, thank you. the CEO of my company has said he is resistant to acquisition since that would be "bad for our customers" and is basically looking at IPO or bust... and I really think it is unlikely we IPO

answer by deluks917 · 2020-09-23T02:03:20.369Z · score: 3 (2 votes) · LW(p) · GW(p)

Keep in mind you are not getting the same terms as the investors. And the valuation is based on the terms the recent investors got. See more details: https://www.benkuhn.net/terms/

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comment by bpunk · 2020-09-22T11:26:14.349Z · score: 4 (3 votes) · LW(p) · GW(p)

Two things to keep in mind when you are making your choice:

1) Exercising isn't a binary decision; you can exercise a portion of your options (ex) exercise 40% and leave 60% on the table to expire. This lets you factor in your personal financial status when you are deciding on your course of action.

2) Many series C startups don't fail or exit. Once a company gets to that size it has a momentum of its own even if it isn't successful. In my case I've worked at 4 startups. Two have exited while the other two are still stumbling along. I left one of the stumblers over 15 years ago so they can go on quite a while!

comment by ryan_b · 2020-09-21T21:15:22.553Z · score: 3 (2 votes) · LW(p) · GW(p)

I agree that answer is high. Unless I have severely misunderstood the text and graphs, they are leaving out the case where a startup does not exit, but also does not fail: it transitions into a sustainable business.

I am unable to locate the source right now, but I strongly recall YCombinator commentary about the number of their investments which transitioned into sustainable businesses, known to them as lifestyle businesses, as distinct from the "big wins" which dominate their profitability.

If I can find it again I will edit.

comment by mr-hire · 2020-09-21T21:20:32.757Z · score: 2 (1 votes) · LW(p) · GW(p)

If the company is at Series C,  but they're not a homerun, they have no way to pay back their investors.

Furthermore, their valuation by definition was too high... so you have the same "dissappearing value" mentioned elsewhere, and your options as an employee are likely not worth that much.  As an employee in such a company, you're also at risk of being laid off, as VC funds were likely put into hiring in anticipation of VC scale growth.

comment by Jessica Shu (jessica-shu) · 2020-09-23T04:17:37.930Z · score: 1 (1 votes) · LW(p) · GW(p)

I have already left the company so not worrying about layoffs at least. Is there any obligation to pay back investors for "lifestyle businesses" or can they can continue operating with investor money indefinitely?

comment by mr-hire · 2020-09-23T16:37:38.222Z · score: 2 (1 votes) · LW(p) · GW(p)

I'm not an expert on this but I believe the owners have a fiduciary duty to try to make the investors whole.

comment by AspiringRationalist · 2020-09-23T02:46:18.586Z · score: 2 (1 votes) · LW(p) · GW(p)

It's also worth looking into what possibilities exist for cashing out your stock. Markets exist for private company stock, though they're much less liquid than that of public companies, and your stock may come with restrictions on your ability to sell it.