This is the fourth installment of my series on How a VC Firm Makes Money. In my last post, I promised to explain the four “exiting events” a VC Firm may use to turn their investment in a company into money:
Initial public offering (IPO) is the act of issuing a company’s shares to the public. There are other names for this such as public offering, flotation, or publicly traded company.
When a company lists its shares on a public exchange, the money paid by investors for the newly-issued shares goes to the company.
This is the best way a venture capitalist can exit an investment in a startup.
2. Acquired / Merger
Mergers and acquisitions can be abbreviated to “M&A”. Mergers mean that two or more companies are joining to become one entity. Acquisitions (takeover or buyout) mean that a company is “buying” another company.
Big companies acquire a lot of startups to expand their own set of products, and to buy talents, users and technology.
3. Staying private
A company that does not release shares into a stock market and is not acquired by another company is called a privately-held company. Most of the small and medium size companies are privately-held companies. Usually, they don’t have a lot of shareholders. A startup usually begins as a private company and later becomes a public company.
Sometimes, the shareholders of a startup may decide that the best way to keep a profitable business is to remain private. Investors may not want to attract the attention of competitors or other companies in its market, depending on the type of technology or market involved. A private company does not have to release quarterly earnings to the public.
Bankruptcy is a declaration that a company or a person cannot pay its debts. Simply saying, a company is bankrupt when it is “out of business”.
This is definitely a situation that every venture capitalist wants to avoid.
Now, let’s see what the exits for Accel’s investments are.
1 - Facebook goes IPO
This is the best way to reward a VC’s investment. The VC buys the shares cheaply in the beginning of the startup life and sells it high after the IPO. Imagine that Facebook would get a market value of $15 billion, Accel and other investors would literally get those amounts of money. Accel would get almost 130 times of their investment.
2 - Yahoo!, Microsoft, etc. buy Facebook
Facebook could be merged or acquired by a larger company. So far, Facebook has rejected acquisition offers. This is not a realistic situation because it is not very easy for any company to buy Facebook in the price range of $5-15 billion, especially in this economic climate. However, Microsoft and Google could have the capital to do so.
3 - Facebook stays private
Most of the VCs would like to avoid staying private. When a company is private, the shareholders cannot sell their shares easily to other investors. Moreover, the price given is not as high as a VC could expect in his shares. In the case of Facebook, which has a lot of shareholders, almost nobody would want the company to be private. Instead, they want to do an IPO and cash in their stocks.
4 - Facebook goes bankrupt
This would happen if the company makes a major mistake that causes them to lose market shares or run out of money and investors. In this worst-case scenario, all investors, founders and employees lose money. The investors can “liquidate” the company, which means they want to sell everything the company has, like a garage sale, and all the money they get is redistributed among the investors. In this case, VCs have some special clauses in their shares that give them preference to receive this pool of money.
Wow! We’re done our series on How a VC Firm Makes Money..
Next, I’ll talk more about valuation, some common questions about VC, news, etc!