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What valuations/ exits are VCs looking for?

After my earlier post on how the sale of business.com for $350 million was an ok deal for the investors, but not an extraordinarily, humongously, great deal, I feel obliged to post something on my understanding of what investors consider a good investment. To be sure, for a company (business.com) that was expected to go under, being able to pull off the acquisition, was an accomplishment. However, large amounts of money had gone into the site, which in the end, was essentially a directory - a victim in some ways to the excesses of the bubble. Business.com was fortunate to have the financial backing that it did.

So what is considered a “good return” in venture land? It depends on the stage of the deal. Here are some rough guidelines for early stage companies, along with some “VC-speak” that you might hear, when such exits are discussed.

1. Company exited at 0-1x (ie 0 to 1 times the money invested)
“What company? What investment?”

Nobody made money. Founders are broke.

2. Company exited at 1-2x
“We broke even on that deal”

This is not the deal that the VCs are going to brag about.

Generally VCs have “liquidation preference” clauses which mean that they get to take out their money first. Very likely the investors made nothing after the debts were paid off. Founders are, very likely, still broke.

3. Company exited at 2-5x

“We had a good exit”

VCs made some money. Founders made some depending on how good they were at ironing out the initial term sheets. The founders are planning their next venture. Unless the numbers were large, this is not enough to retire on.

4. Company exited at 10x and above

“I told you this was going to be the next Facebook!”

This is the 1 in 20 or so “make the fund” deals that funds hope and pray for.

VCs are entitled to crow, and they do! Everybody is happy - mostly.

Side note for entrepreneurs on valuation: When presenting a business plan, if you are showing a company that is going to be worth 2x in 3-4 years, then it is time to go back and look at the market size and other factors. Most investors will beat a fast path to the exit sign unless they can be shown an expectation of about a 10x or more, or more on their investment, in 3-5 years.

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July 29th, 2007 Posted by Toni DasGupta | Venture Capital, Entrepreneurism, Opinion | no comments