The Startup Game Takes Years. No One Wants to Hear This.
Frothy markets bring out short-term players in droves. Sure, why not use hard-earned savings to go long way out of the money calls in [fill in random stock ticker] which fits some chat room short squeeze formula. Or better yet, buy some random [fill in random crypto coin] just because it’s up 60% overnight. For the common investor, this isn’t prudent investing, it’s quick trading or outright gambling, and it’s like trying to cross No Man’s Land without stepping on a mine.
True capital growth takes time and the startup game is a long game for all involved. We continue to see more and more new faces to the startup game act like short-term traders, and this will not end well for many of them. Founders, venture capitalists, and LPs are forced to learn patience and sometimes wait 10+ years to get capital returned (if capital is returned). From our perch at Promus Ventures, let’s look at the big picture of what is required:
Founders:
Do you have a long-term vision? Does your startup solve a pain problem so deep in your soul that you will work for very little to solve it? Are you willing to give 15 years of your life to build something that will endure?
The answer to many of these questions from the day we meet a team is usually murky. Oh, of course, we have a long-term strategy! It is to take over the world and become a $20B company! Glossy business plans or decks with ever-increasing projected numbers don’t cut it.
The determination and grit in a team’s eyes and actions are the proxies for success. A thesis that has been brewing for years (sometimes since childhood) is the cornerstone, and come hell or high water this team will solve this pain point. We can tell pretty early if a founding team is prepared to take on the mountains that are ahead or if they’re in love with the sexiness of telling their friends they run a startup.
Founders are the frontline — they have the most difficult job of anyone in the game. Because of this risk, they can be rewarded with life-changing amounts of money when successful. Growth round secondaries for founders in top startups have taken the sting out of working for nothing until the exit, but the majority of teams still walk away after all their hard work with little to no value for their equity. It’s a hard road.
VCs:
Carry is the vehicle for venture capitalists to generate wealth, and VCs can only start tapping this until after their entire fund plus management fees and expenses (and for some funds, hurdle rates) are returned to LPs. Suffice to say, unless there are early and large exits for a fund, this carry can take years and years to payout.
The management fee is what is used to pay the bills, and 2% of commitments for a small venture fund does not go very far (you do the math). VCs have to start out paying themselves and their teams very little for years until they show stellar DPIs and TVPIs. Once here, they must in turn go back to existing and new LPs to invest in future funds. If exits take a while, and capital is not returned, LPs will many times wait until those paper returns are realized and in the bank before making new commitments.
The beauty of carrying is that both the LP and the VC are aligned. LPs are happy to share 20% of all upside returns after getting all their upfront commitment back. No returns? Sorry Charlie, no carry. Hope the management fees paid the bills.
Once again, the theme that comes through is time. Success does not happen overnight. Paper returns are just that — nothing counts until it hits the bank. Just like founders, VCs have to look a decade into the future, as that is what is required to build a top-tier franchise. We are nine years into building Promus Ventures, and it feels like we are still in the early innings of where we want to go. No quitting here — you do or you don’t, and you better know the choice when the shingle is hung.
LPs/Investors:
Whether an LP is investing directly into a startup or through a fund, they are hamstrung on seeing any returns until an exit occurs. “So when do you think we will see some exits?” is a popular question from LPs. And why would it not be? There are no sell buttons when investments go south for LPs, just waiting for the team to turn the ship back around (hopefully). The best LPs are those with patient long-term expectations. They expect multiples on their commitments and know great companies cannot be built in a day.
The last years of this incredible equity bull run (fueled by low-interest rates) have enabled founders to wait to put on their big-boy/girl pants to become a public company by continually raising growth round after growth round. SPACs have recently returned in popularity to create a quicker way for exits in today’s market (although at the end of the day the company still has to comply with the onerous responsibilities of being a public company). LPs will cheer these exits as long as the market rewards high growing companies with continued high valuations. An overbought market can stay overextended for long periods of time, but not forever.
If you want to play, the only option is to buckle in. The world of founders, VCs, and LPs is not all sunny days and quick cash returns. Just with anything in life, nothing great comes without sacrifice and that requires working hard, taking knocks, and forging on. As we have said over the years, it is a long bus ride, so you better enjoy the passengers you are with and don’t forget to pack some extra sandwiches and snacks.
Recipients of this post are not to construe it as investment, legal, or tax advice, and it is not intended to provide the basis for any evaluation of an investment in any fund. Prospective investors should consult with their own legal, investment, tax, accounting, and other advisors to determine the potential benefits, burdens, and risks associated with making an investment in any fund.