Hi all-
I'm a recent vc-backed tech founder. The state of funding in the very risky 0-to-1 startup market seems to be less expensive than equity funding in the much-less risky going-concern market - and I'm curious why.
In the VC funding market, there is typically no annual dividend, and often no preferred return. We raised our round at a $25MM valuation cap, with no discount, no dividend, and no preferred return or return multiple. When I hear that these have become standard acquisition equity terms, I'm bristling at the potential cost of it. Can anyone explain to me why there are so many Investor dollars chasing deals, but entrepreneurs have been unable to push back against these deal terms for much less risky ventures?
Why is Acquisition Equity more expensive than VC Equity?
by a searcher from Georgetown University
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In the VC market there is an almost unlimited amount of capital, constantly being replenished from huge institutional sources (pension funds, insurance companies, etc.) that require an every-increasing stream of investment returns to meet their obligations. That puts pressure on VC fund managers to constantly book new deals; if they don't, they don't get further capital allocations. As a result, VC fund managers compete to attract deals by offering the most attractive (i.e., least costly or restrictive) funding terms. This has led to an erosion of investment underwriting criteria in the VC ecosystem, especially with respect to 'tech' deals.
Those characteristics do not apply - indeed, are reversed - in the searcher market where there is still a relatively limited capital pool provided mainly by non-institutional sources. As a result, the funding dynamics of the searcher ecosystem are very different. Funders are much more selective in their approach, more granular in their analysis, and more restrictive in their terms.
This is an example of the oft-cited dichotomy between Wall Street and Main Street. The investment terms that you thought were 'typical' are, in fact, only typical in the VC ecosystem - on Wall Street. Main Street, where the searcher ecosystem resides, is quite different.
[^Searchfunder member, thanks for including me.]