From the February 2010 issue of Investment Advisor • Subscribe!

Venture Populist: Venture Hits and Exit Wounds

Sometimes there is no outcome

I have noticed that venture capitalists tend to talk more about their home runs than their strikeouts. Angel investors, on the other hand, prefer to relentlessly revisit their pain. Maybe that's because angels put up their own capital. They truly eat their own cooking so it's harder to forget their fallen souffl?s.

VCs achieve their highs from the opium of OPM (that is, Other People's Money) ...so even a bad trip is still a free trip.

I recently had lunch with an inveterate venture investor (aka "angel") whom I had co-invested with in a biotech, as well as a med-tech, company, several years back.

The biotech company was a true home run--a high-multiple exit realized in a 2004 IPO. But rather than relishing in a reminiscence of our raison d'?tre, we chose to get muddy in the mire of our miss--the medical company that nearly seven years later was still trudging along with neither an exit nor a write-off in sight.

There is the baneful scenario--five or more years in an illiquid private investment that just keeps rolling over but never plays dead, and then there is the painful scenario--a company running profitably for several years straight but no IPO, acquisition, or distribution on the near horizon.

What to Do, and What Could Have Been Done?

Two questions dominated our discourse. First, what would become of the med-tech investment? Second, what could we have done differently as investors to avoid non-outcome outcomes?

My most previous venture ovation in this column opined, "There is very little that is binary about venture investing outcomes. It is not just feast or famine...outcomes are diverse and asymmetric. You can lose your entire investment, just lose a portion, break even, receive periodic distributions producing double-digit IRRs or achieve exits at 5x, 10x, 20x multiples, or greater..."

That list of outcomes would be just fine if it was indeed comprehensive, but I employed some autistic license. The reality of the absence of binary outcomes in private venture investment occasionally includes the potential absence of any outcome at all.

In an entertaining piece called "10 Exits," Angel Capital Association chairman John Huston further parses this purgatory (download his complete version here). He evokes the venture vernacular "Zombie" as "a walking dead venture that will never become a great company, nor will it die so I can declare the loss."

There are a number of ways to euthanize a zombie but what do you do about the investment that Huston calls, "My Grandkids' Company...a company that is successful but there's no exit in sight"? ("Maybe it will occur after my grandchildren inherit the portfolio.")

That brings us to the second question, and yes, there are methods that an investor can apply at the outset of the investment that mandate distributions from profitable private companies.

I have developed some effective term sheet and funding mechanisms that avoid inadvertently gifting your grandchildren and I will share them in coming versions of the Venture Populist. They are the byproduct of my own experiences, and as you probably know, experience is what you get when you were looking for something else.


Jeff Joseph is a financier, entrepreneur, CEO of Prescient Advisors, and the author of the blog at www.venturepopulist.com. Send Jeff comments, questions, and column suggestions at joseph@4prescient.com.
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