This week's $250 million funding for vacation home rental listing company HomeAway was the largest Web-related venture capital investment since the bubble days at the turn of the millennium. But it also contained a provision that signals how the lack of venture exits may be causing some entrepreneurs to ask for cash now rather than wait for an initial public offering or sale that may never come.
As part of the HomeAway financing, a portion of the money will go toward repurchasing some of the shares held by employees and early investors in the Austin (Tex.) company. CEO Brian Sharples wouldn't disclose how much money, or what percentage of shares, affected employees would be able to exchange for cash. Such deals have been fairly rare, but in the last few months I've talked to a growing number of entrepreneurs who have negotiated them. That they're becoming more common, especially among younger companies, shows how, for some, the economic downturn is undermining faith in the venture model.
That model is one that rewards entrepreneurs and investors for building a solid business over a 5- to 10-year period, then selling it, either to the public through a stock offering or to an acquirer for a sum that makes those years of work worthwhile. It's the American dream, Silicon Valley-style. But what if entrepreneurs aren't willing to wait that long? And what if the exit markets aren't open?
Exit Doors Are Closing
As the HomeAway deal and others like it show, that's precisely the environment we're in now. When a venture-backed company does such a deal, it's generally because employees who have taken a lot of equity in it want to exchange that equity for cash. Usually equity holders get cash after a company exits, whether via an IPO, a merger, or an acquisition. With the IPO window shut (so far the total number of IPOs is down by 81% this year) and M&A slowing, that's looking less likely.
Sharples explained the decision to offer shareholders the ability to cash out as a reward for the work employees have done. The company had planned to go public in 2008, but given the climate for IPOs it shelved the idea for at least two more years. This would disappoint any shareholder, but HomeAway is only three years old. For early investors or founders to expect an exit in three years is ridiculous. The bubble years aside, most venture-backed startups don't achieve an exit for seven years. In some cases—clean technology companies, for example—investors are looking at 10 years before a payday.
HomeAway is more of a private equity business model—the company is buying up Internet properties that list vacation homes available for rent in the U.S. and, potentially, worldwide cities—so perhaps that explains the short time to a planned exit. But HomeAway isn't alone. Facebook has allowed its early employees and shareholders to sell some of their shares for cash, even though it is only four years old. Digg, the news ranking and aggregation service founded by Jay Adelson and Kevin Rose, raised $28.7 million in September, a deal that is rumored to have involved Rose taking some cash.
It's a win when employees can cash out, especially in such dismal times, but raising money to buy back shares has the potential to set a lower fair market value for the startup, as well as to dilute the value of shares held by existing shareholders. These sorts of deals are a sign of stress in the venture model, and we're likely to see more of them if it remains difficult to take a company public in the coming year.