Future of the Exit, Post CrowdFunding

In April 2013, equity CrowdFunding is not yet legal in America. In the upcoming years, it will become so. This posts reflects on changes we may anticipate once this change occurs.

Mercantile capitalism has led us to great wealth creation. It has also led us to great wealth destruction. As a result of all that, though, a reasonably robust venture capital industry has now emerged in America. Even though it leaves the vast majority of entrepreneurs unserved, venture capital has been instrumental in creating outstanding companies.

One of the necessary pieces of the venture capital equation, however, is Exit. Whether it is going public, or getting acquired by a larger company, venture-funded companies HAVE TO EXIT. This phenomenon often causes tension between the entrepreneur, who may have a longer term company-building mentality, versus the investor who wants to cash in.

This tension is best exemplified in the legendary Facebook story, recently told by Peter Thiel:

“The most important moment in my mind in the history of Facebook occurred in July 2006,” he began.

At the time, Facebook was just two years old. It was a college site with roughly eight or nine million people on it. And, though it was making $30 million in revenue, it was not profitable. “And we received an acquisition offer from Yahoo for $1 billion,” Thiel said.

The three-person Facebook board at the time–Zuckerberg, Thiel, and venture capitalist Jim Breyer–met on a Monday morning.

“Both Breyer and myself on balance thought we probably should take the money,” recalled Thiel. “But Zuckerberg started the meeting like, ‘This is kind of a formality, just a quick board meeting, it shouldn’t take more than 10 minutes. We’re obviously not going to sell here’.”

At the time, Zuckerberg was 22 years old.

Thiel said he remembered saying, “We should probably talk about this. A billion dollars is a lot of money.” They hashed out the conversation. Thiel said he and Breyer pointed out: “You own 25 percent. There’s so much you could do with the money.”

Thiel recalled Zuckerberg said, in a nutshell: “I don’t know what I could do with the money. I’d just start another social networking site. I kind of like the one I already have.”

VCs secretly hope they would have had the opportunity to invest in something as momentous as Facebook, while also dreading the experience of having to deal with someone as uncontrollable and obstinate as Marc.

Most VCs would have a terribly difficult time with the above situation.

Why? Because most of them lack guts big time.

For those VCs who want to cash out, and for those entrepreneurs who don’t, I think, CrowdFunding can be a blessing. Instead of pressuring the entrepreneur to sell, VCs could instead do a private placement to the Crowd. This Crowd, presumably, will be full of experienced entrepreneurs and investors who are in a position to invest their own money, rather than managing someone else’s. They can provide patient capital in a later stage, proven company if the VCs want to get out.

A second option also seems incredibly exciting to me: CrowdFunding from customers. I recently did a story on Modernizing Medicine and how they raised significant amounts of equity financing from their customers (doctors). What if, the company in conflict with its VCs does a similar private placement round and offers equity investment opportunities to its customers? If the customers are loyal and rich, they could very well buy the VC shares out, without having to cope with all the regulatory burden of an IPO.

Bottom line, while we talk a lot about how CrowdFunding will impact seed stage investment, the real difference, I believe, will be in late stage investment, where the business is validated, proven, revenue (and perhaps profit) generating.

Also, the people who will really take advantage of the relaxation of regulatory burdens will be the sophisticated investors, not the rank and file.

The rank and file, I’m afraid, will get creamed, scammed, washed out, and messed with.