The VC Dilemma – Capital Efficiency or Big Big Exits
A couple of news items sparked a little debate in my mind about expansion capital investor’s biggest dilemmas… Is it better to invest in capital efficient businesses that have lower probability of getting to a big big exit?… or better to bet on companies that are batting for the grand slam, but require lots of expansion capital to do so?
I had a recent discussion with a CEO who is grappling with that choice… He is a CEO that has set his eyes on the grand slam of making his company THE cloud provider in his space. And I truly believe he will pull it off. What he and I debated was whether he should hit the accelerator to sign up as many customers as he can (requires lots of capital, and accelerates top-line growth)… or focus on honing-in his distribution economics and scale within the confines of a profitable distribution model (less capital, slower growth).
The CEO sent me this example of a company that chose the path of capital inefficiency… The company is Evernote and the CEO is Phil Libin. I remember meeting Phil back in November of 2007 when he was just starting his company. The technology was fascinating and I got the value right away. What I couldn’t bet on is how he planned to scale. I suspect Evernote will be one of those companies that I will regret not investing in.
It is a tough call… There are many VCs on either US coast of the US that would advise the CEO and Phil to hit the accelerator hard. These VCs tend to have big big funds that are looking for big investments and big exits. Here are three of them talking to TechCrunch about their big investments in small companies with humongous valuations, and the pursuit of big big exits.
We at OpenView Venture Partners are the opposite extreme of that big big exit model. We look for companies that have (or are on the path of getting to) a profitable distribution model. So using the baseball analogy, we aim for a portfolio of consistent singles and doubles batters… we don’t aim for grand slams, but we work really hard at building great big companies with the least amount of capital.
We are not the firm that would have invested in a Google, Facebook, or even Salesforce.com in their early days. All those companies sacrificed capital efficiency in the early years (Benioff may argue this point) in the pursuit of ‘bigness’. And they had to rely on investors that were willing to write big checks with humongous valuations. For every example of a grand slam, there are tens of examples of companies that missed and cost their investors dearly. The Big Big VCs look to the grand slam to make up for the “failures” in the portfolio, to return the target return for the fund.
Does that mean we have a mediocre portfolio? Absolutely NOT! We aim for each and every company to achieve a minimum return of 5x… we aim to have no company fail… we aim for all of our companies to become big successful companies, with the least amount of venture funding.
Time will tell which is the better model.