Why do some startups part ways with their VC investors (and how)? Like any breakup, it is not easy, but may be better for the company in the long-run, depending on the situation.
Some founders realize that the pressure from venture capital investors just isn't aligned with the vision and long-term goals of the company. In 2018, several startups decided to buy out venture investors.
Innovation & Profitability vs. Growth-at-all-Costs
The most successful, visionary entrepreneurs dream not of millions of dollars, but of a world where their products change culture. But in technology startups, particularly venture-backed technology startups, the current investment climate does not always support that vision.
(New York venture partner).
In 2018, Chris and Brendan, co-founders of video hosting company, Wistia, made an unprecedented decision that has had a ripple effect in the startup community.
Wistia was started when the two founders were just 23 year old dreamers who thought they'd build a company and then sell it and retire. As it turned out, they loved running Wistia just as much as their new employees loved building its products. To top it off, the startup became highly profitable while focusing on creativity and long-term projects.
Initially, Wistia's profits were reinvested to improve its core products. After all, it was the desire to innovate that drove them to work so hard in the first place. However, the tech startup community felt that Wista was actually too profitable and should spend more money on growth. Swayed by this counter-intuitive advice, the co-founders spent massively on advertising, hired a large sales team, and switched focus from innovation and efficiency to scaling the business.
Before long, the once profitable startup began to operate in the red. Without the reinvestment in R&D, employees complained that the company was no longer the one they had signed up for. Eventually, it became clear that the growth-at-all-costs mentality was negatively impacting financials and morale.
When Wistia received three acquisition offers, the co-founders had to decide: either sell the company for a life-changing amount of money, or take on debt to buy out Wistia's venture investors so they could go back to building an innovative, profitable company at their own pace. Many startup founders would not even consider the latter an option.
Incredibly, that's the one Chris and Brendan chose. Rather than selling, they chose to double-down on Wistia, remedy their past mistakes, revive their team and company culture, and focus on long-term growth.
The grow-at-all-costs model inevitably forces you to sacrifice something you care about in service of short-term revenue growth, whether that’s your culture, your employee experience, your products, or your creative approach. But what if you’re not willing to sacrifice those things? What if you actually believe that prioritizing them over short-term revenue growth is the key to succeeding over the long-term?
(Wistia co-founders).
The founders presented their investors and employees with a tender offer (one transparent offer to all shareholders). Some investors wanted to be bought out, although some were so excited about the company's plans that they wanted to stay involved.
Ultimately, Wistia borrowed $17.3 million from private equity company KKR's new $300 million Accel-KKR credit fund to repurchase shares from its venture investors at a 10x ROI and compensate employees for their time. The remaining preferred stock was converted into common stock so that all shareholders would be aligned. Going forward, employee stock options were replaced with a profit sharing plan.
It was a risky bet, but it's working; Wistia's revenue is growing faster than it was before and is profitable once again. The unique decision brought an unexpected onslaught of questions from other founders. Many wanted to know how Wistia did it to determine if they could as well. The demand for more information prompted Chris and Brendan to hold a live Q&A explaining the debt financing that allowed them to keep their business.
In the end, Wistia's employees were much more excited about the profit sharing plan than their previous stock options. The founders found that employees are more incentivized to help increase profits, for which they actually see a tangible benefit than growing a company in exchange for equity, the benefits of which are hard to understand and may never be realized. If Wistia does decide to refocus more on growth in the future at the expense of profit, perhaps this model will need to be revisited then.
Some advice from the now wiser Wistia founders:
Go your own way. . . Don’t assume that more funding is the key to success.
The Buyback Trend is Only Just Beginning
In 2017, app distribution software startup, SweetLabs, made a deal to buy out its investors over a multi-year period using the company’s profits. SweetLabs co-founder and CEO, Darrius Thompson found this option more enticing than the draconian terms he encountered in private equity buyout offers. Darrius says the company is still growing while generating revenue—a business model that VC doesn’t favor.
SweetLabs is a dynamic, independent tech company headquartered in San Diego. We're profitable, reach millions of people, and continuously explore new ideas.
(SweetLabs website, January 2021).
In July 2018, social media analytics company, Buffer, spent $3.3 million—nearly half its cash reserves—to buyback shares from seven of its sixteen Series A investors. The investors that sold received about a 40% annual return.
On its website, co-founder and CEO, Joel Gascoigne, generously laid out Buffer's unusually transparent funding negotiations, letting VCs know that he and his co-funder were not sure whether they wanted to exit or not, nor when. Despite this careful approach, they eventually realized that venture capital wasn't the right fit for the company. Joel outlines the reasons behind their decision to buyback the shares from investors and the strategy taken.
In September 2018, New York based interactive content creator, Arkadium, announced that it had bought out its early-stage investors. Arkadium's co-founder and CEO, Jessica Rovello, says that to build a sustainable business, technology companies need to get away from the de facto VC growth model. According to Rovello:
Operating independently enables you to have a longer-term view, greater control around strategies, and more operating flexibility. We want to be an example for purpose-driven companies that value long term impact over ‘growth at all costs’ mindsets.
Private equity firms have created new credit funds for this emerging buyback market, like Accel-KKR and O’Reilly AlphaTech's repurchase program OATV. The non-dilutive credit allows founders to liquidate investor equity and keep their company (considering they're able to repay on the loan's terms). Unlike commercial banks which will only lend based on cashflow or assets, these repurchase groups focus more on recurring revenue. Loans from credit funds are more expensive than a commercial bank, but less so than venture debt.
In 2015, we began work on a new investment category we call Indie.vc, which is designed to support founders with a focus on customers, revenue and profitability.
(OATV; and the Indie.vc website features a unicorn on fire).
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