Buck Jordan here.
Investing is a super stimulating activity.
As an investor, I spend time reading about the future, meeting founders, building financial models, and making bets on what the world is going to look like in 10 to 20 years. In my experience, investing is one of the best ways to maintain a steady pace of learning and continue to have an eye toward the future.
As fun and exciting as it is, at the end of the day, we’re all in this for one reason: returns.
Startup investing, unlike other asset classes, such as stocks, is a very long-term game. Startups typically take seven to 10 years to begin to demonstrate their full potential and grow their revenue and customer base to a point where they’re ready for an exit.
That makes this space a highly illiquid asset class.
There are only a few opportunities to buy shares in a startup. And once your money is invested, it’s locked away until the exit. While you can potentially do a secondary sale to another buyer, there are a lot of restrictions around doing this, and it’s relatively difficult to match buyers and sellers in the secondary market for startup shares.
So, what are the most likely exits you can profit from?
Acquisitions and initial public offerings (IPO).
The most common exit path for startups is an acquisition by a larger company.
They can buy the startup for many reasons, including to launch new business lines, take a competitor off the market, buy capabilities they don’t have in-house, or to acquire new customers and revenue.
When a larger company acquires a startup, it gets all its shares. That’s why an acquisition goes through an approval process where a startup’s board and a majority of its investors have to vote to approve the move.
After an approval, the larger company buys out all shareholders at the agreed on share price they offered in their bid.
Acquisitions can come in three forms: all-cash, all-stock, or a mix of cash and stock compensation. Typically, as part of an acquisition, the acquirer will ask the founders of the acquired company to stay on for one-to-three years to support the transition.
Some successful startup acquisitions in recent years include:
- Facebook acquiring WhatsApp for $19 billion in 2014
- Salesforce acquiring Slack for $27.7 billion in 2021
- Uber acquiring Postmates for $2.65 billion in 2020
- Amazon acquiring Ring for $1 billion in 2018
- Roche acquiring Flatiron Health for $1.9 billion in 2018
Imagine being an investor in one of those startups and banking profits after those acquisitions.
Well, that’s exactly what you’re preparing for every time you invest in a company raising funds.
The other main exit path for startups is an initial public offering (IPO) – more commonly known as “going public.”
An IPO transforms a startup from a privately-held entity into a publicly-listed company on any of the main stock exchanges, such as the New York Stock Exchange.
Startups typically work with investment banks to successfully pull off an IPO. Alternatively, some in recent years, such as Spotify, have been pursuing direct listings.
An IPO involves a startup creating new shares and floating these shares on the public market for new investors to buy. Once a startup becomes publicly-traded the supply and demand dynamics of the public market will take control of its share price.
Investors in a company that goes through an IPO are subject to a lock-up period, typically for six months. During this time, these shareholders can’t sell their shares. This is designed to stabilize the share price of a company after it goes public and prevent mass sales of shares, which can crash the share price.
2021 was a record year for VC-backed startup exits and saw $770 billion in exits, including several notable IPOs such as:
- Robinhood’s $32-billion IPO
- Coinbase’s $86-billion IPO
- Roblox’s $38-billion IPO
- Affirm’s $12-billion IPO
- Qualtrics’ $15-billion IPO
So, there you have it.
As startup investors, we’ll make our money through an acquisition or IPO.
Many of these exits could be in the hundreds of millions – or even billions – of dollars.
The good news is every new exit adds to a growing dataset.
I personally use these previous exits as benchmarks when evaluating new investment opportunities. It’s useful information to know that Postmates was acquired for $2.65 billion, or that Coinbase’s IPO valued the company at $86 billion. These are benchmarks for me to keep in mind when evaluating new startups in the same category.
Keep your eyes peeled for news on startup acquisitions and IPOs to use as benchmarks of your own as you evaluate new investment opportunities.
And stay patient. Startup investing is the long game, but the returns make the wait more than worth it.
Until next week!