The secret to start-up and venture capital success is to buy low and sell high – full stop. I suppose this advice is not really a secret but most people think of this sound bite for public stocks and retirement savings plans. It also holds true for start-ups. The only way to create shareholder value and serious pocket change is to increase the spread between the dollars in and the dollars out. So buying low and selling high is all relative.
Ok, here is the real secret to success – ownership efficiency. The founder’s sweat equity, the employees stock grants and the VC investors bucks all convert into an ownership percentage in the company. The goal for everyone should be to provide the appropriate amount of capital to achieve growth that leads to a pay day. It’s obvious that the more investor cash that goes into the company, the higher the sale price tag must be for everyone to achieve a healthy return.
I don’t want to get into the gory details of VC financing terms but you should think of a company’s value as a stack of pancakes. The founders and employees have common stock which is the bottom pancake and every financing adds more pancakes to the pile. When an exit happens the top pancakes suck up all the syrup while the bottom pancake just gets cold.
The management and the investors’ goal should be to efficiently convert every equity dollar invested into value. Staying ownership efficient allows management and the brave early investors to be rewarded by maintaining their ownership positions. It also increases the chance of achieving a meaningful spread between the dollars in and the dollars out. Billion-dollar cash exits are rare so don’t confuse them with billion dollar private company valuations which are not so rare. I struggle when entrepreneurs and investors brag about significant capital raises, especially those at lofty valuations. What I see is that the people doing most of the work (founders and employees) are getting buried under a huge stack of pancakes. Where’s the return? It’s in ownership efficiency, not building a big stack of pancakes!
Author: Scott MacDonald, Co-founder & Managing Partner, McRock Capital
