CONVENTIONAL VENTURE CAPITAL SERVES ONLY 4% OF STARTUPS WELL
Venture Capital was designed 74 years ago to fund innovation; it was not designed to fund privately held companies that are the foundation of economic stability. To date, fewer than 4% of venture-backed equity-funded companies have had successful exits within 8-10 years and more than half of all conventional VC funds are not returning ROI to their investors. The results of conventional venture capital funds should give investors, entrepreneurs, and civic leaders pause: 80% of all venture-funded companies fail within five years, 16% continue to operate, but never return capital to their funds, 3.7% provide a positive exit for founders and investors (CAE 2019 study).
Clearly, with so many venture-funded companies failing and failing to return ROI, it is evident that the conventional venture capital equity funding model that requires an exit (sale or IPO) is rarely suitable for either investors or entrepreneurs. What’s required to improve outcomes for investors as well as entrepreneurs is a fresh and appropriate funding model.
Returning capital to investors more quickly and in a more reliable manner is one substantive improvement a venture capital firm that offers Structured Exits can provide over conventional venture capital funds. Where conventional VCs focus only on unicorns, which by definition are rare, funds offering structured exits offer similar capital returns (the goal of both fund types is generally 3x) to investors without forcing companies to exit or die in the process of trying. As such, these structured exit funds are better equipped to invest in under-represented founders, a sustainability goal for many of today’s investors.
“I don’t think people appreciate the inordinate opportunity that’s out there”
– Carla Harris, Vice Chair Global Wealth Management, Morgan Stanley referring to multicultural & female-led tech startup investment opportunities
STRUCTURED EXIT INVESTMENT MODEL INCREASES STABILITY AND ROI
The Structured Exit investment offers a conventional venture capital investment with reduced risks, shorter time to liquidity, and opens the opportunity to invest in strong, midsized companies that are the foundation of the economy.
Example: A Structured Exit-based Fund invests $5M in a company for 5M shares. The investment agreement specifies a 3X ROI ($15M) if the company buys back those shares within 48 months. If the company takes more than 4 years to buy back the shares, then the company will pay a premium for each share, such that the fund will receive 4X or $20MM.
The Agreement also contains elements that help to ensure the viability of the company. In this example, the fund invests capital in a company that is currently generating $200k in monthly recurring revenue (MRR). The company will use the invested capital to expand sales. The agreement states that in any month in which the company has revenues of $400k or more, the company will use 15% of gross revenues to purchase back the stock at the agreed price until acquired in full.
Each investment is crafted to balance risks and potential rewards. All rights of conventional venture capital investments are maintained, including tax treatments. Additional considerations are crafted into the agreement to provide investors rewards if a profitable exit for the company is achieved within a reasonable period of time following the completion of the structured exit. Benefits of structured exits include substantively reduced risk and time to liquidity, favorable tax treatments, and improved opportunity to obtain returns that are commensurate with the risk of the asset class.
The chart below is an example of what this would look like if the growth of the company is reasonably strong, but does not scale with the classic ‘hockey stick’ curve that conventional VCs look for. In the scenario above, it will take just under seven years for the company to return 4X to the fund.
Stock is purchased from 15% percent of gross revenues (G.R.)
This chart demonstrates that with a very strong growth of 2x year over year, the company would provide a 3X ROI to the fund in less than four years.
WHY INVEST NOW IN WOMEN-LED STRUCTURED EXIT VENTURE FUNDS?
Conventional venture capital does take advantage of the broadening entrepreneurial base. 98% of venture capital decisions are made by white males over 50. Under 3% of venture capital is invested in women-led and diverse tech startup leaders; less than 2/10% is invested in leadership teams with women of color. Kauffmann Fellows reports note that women VC Managing Directors invest in startups with a woman on the executive team nearly three times more frequently than all-male venture firms. Women VCs are nearly four times as likely to invest in companies with women CEOs (58% vs. 15%). and women VCs engage more deeply in the success of their investments by taking a board role in the companies in which they invest.
BUSINESS CASE FOR INVESTING IN WOMEN STARTUP LEADERS
Data shows that when women are at the helm offers investors, exceptional opportunities for outsized returns are increased. Equity investments in qualified female-led technology companies at Series A provide investors with advantageous entry valuations, reduced dilution, and increased average ROI upon exit. In the last two decades, venture funds results demonstrate that investing in women-led, diverse teams have produced double-digit improvements in ROI for investors, as well as better outcomes for founders, employees, and the economies in which they operate. Studies from Forbes, Fortune, Pitchbook, the Kauffmann Foundation report that women business leaders in the private sector return an average of 35% higher ROI to investors.
At the Series A stage, women command just 18% of male-led team valuations
Women-led startups are 66% more capital efficient, raising 44% of the capital raised by men
Women & men raise Series B & C rounds and exit at the same rates1
Upon exit, women-led teams consistently return an average of 35% higher return on equity to their funds
Special Thanks to our Contributor:
Gillian Muessig & Anne Kennedy
Managing Directors at Sybilla Masters Fund
gillian@masters.vc | anne@masters.vc
+1.206.930.8133
www.masters.vc
Gillian Muessig and Anne Kennedy are co-founders of Outlines Venture Group and Managing Partners of the Sybilla Masters Fund. With Mastersfund, they invest in diverse teams led by women, at the stage of first revenue using structured exit funding. They also co-host podcast VC Confidential, weekly on WMR.fm.