July 13th – July 19th
PERSPECTIVES by Eric F. Risley
Successful early venture capital investing requires a ruthless capital allocation strategy. The practical implication is strong-performing portfolio companies get the attention and capital support while others get rationed or simply cut off from additional funding. The vast majority of young companies fall into the latter category.
We are well into this cycle with the crypto industry. In fact, a large proportion of crypto M&A is what is euphemistically referred to as “finding a good home.” Modest consideration paid, often in non-cash form, with technology and team the primary assets.
From the outside it’s hard to discern, but clues abound if one cares to look. Terms like team and technology, lack of announced (or leaked) transaction value, primarily equity or token consideration, shared investors…
These types of transactions are healthy and redirect talent and technology to better use; however, we consider them “tactical” transactions. Modest value and modest impact.
On the other hand, “strategic transactions” have high impact and often feature premium value paid. These are the transactions that get the fawning headlines, return a VC’s fund allowing them to raise their next fund, and make founders and early employees wealthy. Far, far fewer but required for the entrepreneurial model to sustain itself.
What’s the ratio? Venture capital studies indicate that about 20% of investments would be considered an individual success; however, roughly 5% of those have to generate greater than 10x invested capital to make up for the 80% returning less than invested capital.
The ratio of strategic M&A transactions is lower, roughly 10%-15%, as very successful businesses often remain independent and eventually become publicly traded.