Ditch venture model, say founders buying out early investors
Equity-repurchase funds aim to help VCs clear out backlog of portfolio companies
Venture capitalists have portfolios full of startups looking for exits.
Meanwhile, despite churning out profits, many of the startups show no sign of becoming the next massive venture exit.
Instead of forcing their VC backers to go on waiting for a good outcome, some founders of these startups are choosing to end that uncertainty by buying out early investors to deliver them a return now.
One such startup, video specialist Wistia Inc., in November repurchased shares from early investors in a $17.3 million debt transaction backed by AccelKKR’s new $300 million credit fund, which closed this year to finance such deals.
Buyback investors tout these deals as an alternative to venture capital, which is mismatched for startups that may be profitable but are lacking impressive growth rates.
Many profitable startups run out of good options after raising venture, says Bryce Roberts, founder and managing director at O’Reilly AlphaTech Ventures.
“The venture community has bought into this winner-take-all idea,” he said. “What happens when you aren’t a unicorn? Historically
that means a fire sale or it means being left for dead.”
Founders looking to buy back equity and own their companies outright are turning to groups like Accel-KKR’s fund and O’Reilly AlphaTech’s repurchase program. They can provide liquidity to venture firms that are sitting on a backlog of startups and they free founders of pressure to meet venture investors’ high-growth expectations.
Wistia co-founder Chris Savage, who previously raised $1.4 million in seed funding, needed more cash to build out his company but didn’t want to raise venture capital. Growth had slowed and he didn’t want to sell the company.
While commercial banks may lend only based on a company’s cash flow or hard assets, AccelKKR’s fund focuses on recurring revenue, typically from software companies.
“We know the value of that recurring revenue,” said Samantha Shows, an Accel-KKR principal.
Since launching last year, Accel-KKR’s fund has done seven deals, according to Tom Barnds, a managing director at the firm. Unlike venture debt, which often is part of an equity round and matures at the next venture round, this debt is for founders who don’t want or need venture capital. It’s more expensive than a commercial bank but cheaper than venture debt.
“This is another option for owners of businesses—it’s nondilutive,” Mr. Barnds said.
Following the deal, Bostonbased Wistia now is growing with a revenue run rate of $32 million, Mr. Savage said. The startup converted its preferred shares to common stock to align interests of all shareholders. This was possible because the company was doing well—preferred shareholders typically don’t want to be converted to common—so early investors made a return of more than 10 times their money, Mr. Savage said.
Wistia’s founders have increased their stakes in the company by 25%. Employees now receive annual profit-sharing checks instead of stock options, Mr. Savage said. Since it is no longer venture-backed, Wistia doesn’t have the pressure and can grow at its own pace.
“We now have this lasting business,” Mr. Savage said. “It changes how we think about the product and marketing.”
Another approach, O’Reilly AlphaTech Ventures’ Indie.VC program, invests $100,000 to $500,000 in startups like a structured-equity buyback. The program, which has invested in about 20 companies, aims to give startups flexibility and reduce dilution. As the startup pays the money back, Indie.vc’s equity stake decreases over time until it gets a maximum return of 3 times its investment. If the company pays the 3x within three years, Indie.vc’s equity option gets cut in half. If the company raises additional capital or gets acquired, the investment converts to equity. The program has invested in about 20 companies.
Some startups are completing buybacks without a third party. SweetLabs Inc., an app development startup that had raised about $21 million from firms including Bessemer and GV, agreed last year to buy out investors over the next several years, relying just on funds from company profits.
Darrius Thompson, co-founder and chief executive at 10-year-old SweetLabs, said the deal was better than private equity buyout offers he received, which had draconian terms, he said. His deal increases the value of shares for founders and employees, who hold common stock, by reducing the number of shares outstanding.
“We’re continuing to grow,” Mr. Thompson said. “We happen to be very good at generating revenue. The venture model doesn’t happen to reward that. The venture model’s really about growth.”