Exit Early

Open source technologies, APIs/Mashups, and Off-shoring have dramatically reduced startup costs. Could cloud computing and scalable public systems lower barriers to entry enough to delay or even forgo VC investment and usher in a new wave of innovation? Answer would largely depend on how VC funds are primarily being used by the startup (development, marketing, or really scaling).

From http://due-diligence.typepad.com/blog/2009/07/behind-the-cloud.html

The combined reductions created by off-shoring and open source had already led to what I’ve called two-stage ventures, where engineering to the point of market test could be accomplished with minimal startup funds. Now public cloud offers the would-be net entrepreneur a way to avoid both the upfront costs of putting service infrastructure in place for a launch, and the ’success failure’ risk of not being able to obtain capital or equipment fast enough if the offering turns out to be a hit. In an extremely tough fundraising environment, staying capital-light as long as possible is just the ticket. The upshot will be even more ‘below the radar’ ventures launched on personal or angel funds, and only turning to venture when and if they prove demand and require external capital to scale their marketing.

From http://blogs.wsj.com/venturecapital/2009/07/23/angels-more-in-tune-with-ipo-companies-than-vcs-study-says/

An academic study published in 2004 said initial public offerings are more often underpriced when a company is venture-backed than when it is not. This means the company pockets less from the IPO than it might have had the offering been priced closer to what the market would bear…

Now, researchers at the University of New Hampshire’s Center for Venture Research have refined the thesis to suggest that underpricing is less likely if a company is backed by wealthy individuals, called angels. This is because the angels are more likely than VCs to sell shares as part of the IPO. Venture investors generally claim any market gains when they sell or distribute their stakes after the six-month lockup.

“While venture investors are prone to underprice IPO firms, reducing the proceeds from the offering, angel investors have incentives more aligned with non-venture capital pre-IPO shareholders,” says the working paper, authored by UNH Professors William Johnson and Jeffrey Sohl, the venture center’s director.

The full UNH working paper is available here

Assuming founders, voluntarily or involuntarily, are subject to the same lockup as VCs, then this doesn’t ultimately affect their proceeds. It does beg the question of what VCs stand to gain by a post IPO pop. More bragging rights, less effort needed to subscribe the offering, better relationships with investment bankers, etc.