Built To Fail. Founder Equity. The reality of VC-backed companies.

As seen on Jason Njoku’s blog

75% of VC-backed internet companies fail. But that’s okay. Because the 25% that make it can easily return the entire loss [75%] and some for investors. Typically, this is expected to happen within 7-10 years. For the record, this is a ridiculously short period of time for creating hundred million dollar or billion dollar companies. There are very few industries outside of internet and technology which can create such immense value from essentially nothing. Statistically, the most likely end for iROKO would be failure. 75% live in that universe. Obviously my job is to try and position ourselves in the 25 percentile. But failure in a VC world means something totally different than failure in a ‘normal’ sense. If in 2020 iROKO was generating $9m in annual revenue with say $1.5m in profit and growing at 10-15% y-o-y, for my VC investors, that would be a modest failure. What they are looking for is $50m in revenue with or without profits and growth rates of 20-50%. Minimum. With that, iROKO would be worth ‘just’ $300-450m.

A few weeks ago, a very successful East African entrepreneur asked my advice on whether his hard fought profitable business (and 100% owned) was worth abandoning for a more aggressive VC-style expansion. I cautioned him that once he started down that road it’s nigh on impossible to stop or opt out.  Further and further you build towards that reality, the smaller your equity position would become. It ceases to remain your company.

Aaron Levie, arguably one of the most well respected and visionary enterprise entrepreneurs who founded Box, recently filed for a $6b IPO and only owned 6% of his company. His stake could be worth $360m at the above valuation, which, for all intents and purposes, is pretty awesome for the 30 year old. The average VC-backed founder typically ends up with ~10% of the company at IPO. And they are the few unicorns which made it. Zuckerberg was exceptionally fortunate that Sean Parker structured the early fund raises in a peculiar way to protect him and his shares. In the history of $100b+ internet companies, only Bezos of Amazon has a similar 20ish% stake. Even almighty Google founders Sergey and Larry only owned a combined 16% at its IPO. Today their holdings sit at 14% and the combined shares are worth $63b [$30b + $33b]. So it’s all good baby babyeeeeee [RIP B.I.G]

Around the same time, Bastian who has always been more conservative in nature and having joined the company post-$8m raised, condensed it the best way I have heard. ‘VC-backed companies are built to fail’. But if they survive, the results are usually x100 better. The value they create [measured in billions or hundreds of millions of dollars] far outweighs anything which could be achieved in normal environments or in ‘organic’ and compressed time frames. They are immeasurable and x100 better.

In August 2011, Tiger Global lead the series A of iROKO. The little company I founded left the world of normal and we forever entered the world of a venture-backed startup. Previous to that, I had literally no idea about the reality of these companies. I don’t care how many blog posts you read, it never truly prepares you for the new reality. I find speaking to other Venture Capitalists or VC-backed founders possibly the only solace. Outside of that, I find myself everyday fielding questions from media, spectators, iROKOtv fans and other normal investors on iROKO profitability, ability to scale, the large $-sized mistakes, the lightening speed of execution, the constant knee jerk hirings and firings. As always, it’s people who don’t truly grasp the brutal realities of VC-backed companies or in fact think they are pseudo ponzi schemes. Most regular investors or people I speak to fall into the latter category. Internet has been ‘over-hyped’ for the last 20 years. I once tried to explain to someone why Whatsapp was an amazing deal for Facebook. In some of the telco meetings I have been in recently, whatsapp is fast approaching Facebook in terms of engagement on their networks. This is in Africa. The most consistent way for me to communicate through 4-5 cities on my 8 day tours is by using whatsapp. I now use it more than Facebook. Once upon a time Facebook was a fad. A joke. In 2011, the year before they filed for their 2012 IPO, they had annual revenues of $3.7B and $1B in profits. Last week they released their quarterly revenues which were $2.91B and $791m in profits. 3 years later they make almost what they made in an entire year in a quarter. There a few other businesses which can do that. And they are still growing.

Globally, it’s basically the same internet economics. Over the last few years, I have had the chance to speak to most of the VC-backed Nigerian internet founders. The pressure is the same. I have met big name internet entrepreneurs from Russia, India, Indonesia, Brasil and the US. It’s always the same. Go Big. Or go Big. There isn’t really a home. Just zombie, slowly winding down status. That’s why a company can roar to a $300m valuation then inexplicably ‘die into a zombie’. If you want examples I can literally give you many. But here are a just a few – Shoedazzle, Vostu, Viddy, Digg, Livingsocial, Slide, RockYou and many many others.

From Quora

Box S-1 Filing (March 2014): Aaron Levie is down to a 4% stake heading into the Box IPO. How does he feel watching DFJ and USVP laugh to the bank after 10 years of sweat, blood, and tears?

Aaron Levie Responded

So far, I have yet to bleed while building Box (well, one time I was late to a meeting and cut myself shaving). And honestly, if anyone is regularly bleeding while building a software company, I would have some serious questions about their strategy and if they’re executing properly. Definitely lots of tears and sweat though. Start your company because you want to change the world, and the rest is gravy.

This is a confidence game. If you have the required balls of steel to make mistake after mistake after mistake and still feel you need to raise $100m more at crazy dilutive valuations to make this thing just work, then you’re good – you stand a chance. No real crisis of confidence allowed. Because you have to consistently explain to investors those crazy experiments you keep making, which lose millions of dollars, are actually yielding hidden operational value. It isn’t easy. It isn’t pretty. You will spend most of your time appearing to be the last fool in the village to bystanders, your very sanity being questioned at every turn.

But in the end, the ride is awesome. If it works out, you join the 1%. If it doesn’t, there is always another rocket to ride.

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s