For an investor in a startup, return on investment is as simple as writing a check now and depositing some related money later. And since startups are risky, you’d expect to hit big when you win because you’re so much more likely to lose. Does that make sense?
So when the angel investor writes a $50,000 check today to invest in a startup, getting $100,000 back out of it five years later is not bad – it’s slightly less than 14% per year return – but it’s not spectacularly good either.
After all, that same investor could buy a cool car or put a down payment on a vacation condo instead. Or she could just leave that money in a bank with decent interest and have $70,000 in five years without risking losing it all.
But here’s the counter-intuitive catch: What happens if the $50,000 creates a healthy and happy company that grows and becomes independent and never creates any liquidity for its investors? The founders don’t want to get bought, and the stock market doesn’t accept it for a public offering, so the early investors are stuck with a share in a long-term business. Growing businesses don’t generally produce dividends, so that $50,000 investment is stuck.
The return on investment of a $50,000 check that never produces a deposit is way less than zero. Getting $50,000 back would be a zero return. Getting nothing back is – well, let’s just say it’s bad. Real bad.
All of which I post here to explain this statement:
Investors are more interested in companies that will be bought. Not in long term companies.
That’s not exactly what I said last Thursday in my credibilitylive.com session for Dun and Bradstreet Credibility Corp; but it’s close enough. If you’re curious you can click this Youtube link to go directly to seven minutes into the interview where I was was saying that.
Investors appreciate long-term success as much as anybody. But a long-term successful company finds a way to reward its early investors. Maybe that’s through subsequent rounds, a partial liquidity event, a buyout, or some other instrument. But you don’t leave investors stuck in your company with no way to exit.
When my business confronted a situation like that, we practiced then what I’m preaching now: we bought our investors back out of the company.
2 thoughts on “Long-Term Successes Don’t Leave Out Investors”
In my opinion, there are only three ways a startup can become a “success”:
a) getting acquired
c) becoming a lifestyle business
Everything else is just a step on the way to one of those.
What you describe is option C, in which case it would be a failure for external investors indeed. But if there are many siginificant such investors (angels and VCs), it would never come to that, as they would exercise their control rights to opt for one of the two first options. But if there is only a few smaller investors, angels and such, it shouldn’t be too difficult for the founders to raise a loan and buy off those investors, or perhaps convert their shares to a profit-sharing deal.
Thanks Berislav, well said.
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