The bumpy road to exit

I have some investments in startups that have been slowly progressing over now more than 10 years, and still no exit and no dividends. The value of the resulting companies had better be really large multiples of the invested capital to justify this amount of time to exit or dividends. And yet I have many other investments that have done far worse, most of them failing in one way or another.

And yet, here I still am. Semi-optimistic and semi-careful. But it's time for an accounting, and you should know what I know about this road.

Frauds

I have encountered perhaps 3 real frauds in all the equity positions I have had. One was just lying, one ended up over their head in the desire to hack growth, and one was not providing the whole truth of how precarious their situation was. I am also aware of several other frauds that I did not invest in, not necessarily because I was smarter than those who did, but because they were not on the top of my list when I decided to invest.

Crashes

Most of the failures are from companies running out of cash and the ability or willingness to continue hauling a heavy load up a steep hill.

CxO Deaths

I have had two friends die in office as executives in companies I invested in. Their companies that had not yet reached the level where there was enough redundancy to sustain without the extraordinary effort of one or two key individuals, so their companies died with them.

Slow crashes

Most companies that have failed have been what I will call slow crashes. They tried but just couldn't do it. Little or no money in, unable to find a path to revenue in excess of costs, they keep on trying but just can't seem to get there. These usually took place over periods of several years. They are the most painful to be part of and to watch, because they take so much away from the CEO. Some have lost their spouses along the way, others have become estranged from families.

Fast crashes

Better than slow crashes are the fast ones. They are just as financially painful, but far less emotionally draining. Some people think it's better to lose the same amount of money more slowly, and if that's because of a slow drain on a substantial sales volume, it's also usually a side effect of inadequate adaptation. But most of the fast crashes I have seen are from inexperienced leaders not taking advice. The other ones were already crashing and didn't show it, which is a side effect of too little diligence on my part, but frankly there is also a bit of dishonesty on their part. Due diligence depends on the level of investment, and at lower levels of investment I typically operate at, the time and effort in diligence is usually not worth the dataset it's written on.

CEOs who don't adapt

Generally, they ignore advice, ignore facts, and assume they are right in the face of the evidence. It's often hard to detect this early on, but it might be a personality trait to avoid. On the other hand, I am and have in my lifetime also been less flexible than others might like, and it often led to success and failure (sometimes one, sometimes the other). I cannot really blame others for being too similar to me, and I bet on myself every day. Nevertheless, I have managed to adapt well enough to still be here after running startups since the 1970s, so I do look for CEOs who are smart enough to know that they are not smart enough to do it on their own.

Mistakes

This comes in 2 forms. One big mistake or many smaller mistakes.

• One big mistake: Big mistakes come from a lack of adequate risk management (making a catastrophic decision based on inadequate or incorrect information). This is usually symptomatic of a lack of (adequate) process and inadequate group decision-making. On the other hand, quite a few highly successful people bet it all on a guess and won. But what we don't usually see is the other 10,000 times as many people who made similar bets and lost. It's a common fallacy of selective data.
• Many smaller mistakes: We all make mistakes, and depending on how close to the edge your company is, it may not take many small ones to tip you over the edge. But the key to surviving small mistakes is having a more mature company. As maturity levels (none, initial, repeatable, defined, managed, optimized) increase, the effects of small mistakes are detected and corrected sooner and lessons learned (hopefully) produce fewer (of the same sort of) mistakes over time.

Mistakes are inevitable, but failure by mistakes is not.

Successes?

I've had a few, but then again, too few to mention. (adapted from the lyrics of 'My Way' first released by Frank Sinatra in 1969 and written by Paul Anka, based on a French song called "Comme d'habitude"). A few small exists have come my way, but the larger ones I am anticipating for the next few years have taken from 5-12 years so far. And time seems to stretch when you are looking at exits.

Delays can be killers. Unless you are vastly wealthy, which very few early stage investors actually are, time eats away at your funds. There is inflation against which you fight by accumulating interest and returns on investments, and there are bills which pull from your cash reserves. If your investments aren't both keeping up with inflation and throwing off enough cash to keep your cash reserves at an acceptable level, you are losing money along the way. Over 10 years, at 6% inflation, you lose about 44% of the buying power of your savings. If you get 6% interest, that compensates for it by giving you 79% increase in the number of dollars available.

But if you have 1 year of cash reserves being eaten away by expenses, that means that in order to compensate for it, for example at 8% interest through slightly better investment returns than inflation, the amount of invested capital you need to sustain net wealth against inflation is about 50 times your annual costs. At USD 100,000 /y of expenses this comes to USD 5,000,000. If you can get 12% interest (about what Venture capital gets on average), you need less investment, but the trap is the cash flow.

Every year you need to have that $100,000 available to pay expenses, and if it is invested in non-liquid assets, like non-public companies, you cannot get your money back out. So after 10 years, you have spent $1M in paying the bills, and if you don't have any exits yet, you will run out of cash unless you started with $1M in cash reserves or have enough invested in liquid assets to pay the bills every month. You don't get the interest on the money you have paid in bills,

You can do your own calculations, but hopefully you can see that the delay in returns is fighting against inflation and has to be high enough to warrant the losses you take along the way. In theory, $5M invested will get you $45M (at the expected 9x over 10 years historical return of angel investment). But in practice, you need to have something like $10M to invest $5M in these sorts of instruments, and the other $5M is just to keep you making enough to pay the bills. So $10M brings you $45M in 10 years if you make enough bets to get the average returns for early stage companies.

Conclusions

Companies fail in lots of different ways, and that comprises most of the exits for angel investors. The remaining exits tend to take many years and time can be a killer, both of cash and of CEOs.

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In summary

The road to exit is rough, long, and dusty. Prepare your gas mask for the stink along the way.