The sale of the navigation apps startup Waze to Google for the princely sum of $1 billion last month is the dream of startup nation − a team of talented entrepreneurs who form a company and within a few years sell it to one of the biggest and most respected companies in the global industry.
Exits like that feed an industry of dreams, one that says that you, too, can develop an application and grow rich with relative ease. The reality, of course, is more complicated. In startup nation’s backyard is a cemetery in which thousands of aspiring young companies have been laid to rest. Hundreds are added every year.
The encouraging news is that even entrepreneurs who drive a company to a successful exit, including the founders of Waze, in the past were partners in companies that failed. Those failures, as much as the successes, are part of the industry’s business model on which the world of technology’s startups and venture capital are built.
At the same time that Waze was holding talks with Facebook and Google, there were several other startups at a crossroads whose stories ended less successfully. Boxee, whose technology lets users stream broadcast TV channels to any device and gives them unlimited recording space in the cloud, is up for sale after it failed to recruit new investors for a big fundraising round it needed to market its product.
The startup had raised $28.5 million to date from leading venture capital funds and employs 40, but needed to raise twice that to meet its marketing targets. Without the backing, the company is likely to be sold for about what investors put into it.
Tunewiki, which has raised $10 million for a service that provides scrolling lyrics through its social music players for cellphones and hand-held devices, came close to closing up shop. “It’s been an emotional week for many of us but we have some great news. We’re happy to announce that Tunewiki will not be shutting down!” the company announced at the end of last week. “We can’t say much more right now, but we’ll have further details for you soon.”
Most startups don’t advertise that they have shut down. The word only arrives when their founders announce they are starting up a new venture.
Banished from table
“I saw a dinner ready to eat. They gave me a place to sit and put an apron on me. They said in another minute bon appetit and then they said ‘get up from your chair’ and took away the chair − and the table.” That’s how a serial entrepreneur who asked to be identified as Alon describes the experience he has had trying to sell his company, only to see the offer withdrawn.
“Things don’t always happen the way you expect them to,” he says. “But setting up a company and being a part of this world is something I love and enjoy. It persists despite the heartache and bitter disappointments,” says Alon.
The fact is that despite the headlines surrounding deals like Waze, most startups do not even earn back what their investors put into them. According to research conducted by Shikhar Ghosh, a senior lecturer at Harvard Business School, three out of every four venture capital-backed startups don’t earn any payback for their investors. Ghosh based his research on more than 2,000 companies that won venture capital backing of at least $1 million between 2000 and 2010.
That contradicts the VC rule of thumb that out of every 10 companies they invest in, three or four fail entirely, another three or four return the capital invested and one or two bring a significant return.
A survey by the government, looking at companies from 2003 to 2008, found that 46% last just one to three years. Only 8% were in business a decade after their founding.
“Every company works according to its own milestones and work program. The main trigger for closing companies is the board of directors that quarter after quarter management has to explain to why it’s not meeting targets − development, sales or whatever,” says Yoav Kfir, an accountant and CEO of VAR Management, which specializes in helping companies in trouble.
“A CEO like this has to do something more aggressive. You can’t continue doing the same thing and expect that the results will be different,” he says.
Kfir notes that Israelis tend to keep companies alive longer, compared to Americans and Europeans. “That’s part of the culture,” he says. “We don’t like to give up, we want to try again and again and try to succeed if we can.”
But he adds: “A company has a kind of DNA that is very difficult to change and turn it into a phenomenal success that will return investors 10 or 20 times their money. In such a case, it may be better to sell it for two or three times the investment.”
One of the most difficult questions facing entrepreneurs and investors is when to shutter the business. Timing is a critical factor in how to best realize the value of a company’s assets.
“Most companies that are shut down could have been sold a year or two earlier and prevented it from being closed. A company is an asset with a monetary value. There is staff, technology, products and customers,” says Kfir. He says the value of all these assets can be increased, but it requires making the decision early enough, recognizing that the company is heading in that direction.
Homers, not doubles
Most VC funds do not want to sell companies at a valuation that will earn them only twice their investment. “They would rather inject more capital in the hope an investor will buy it later, that something will happen, and they can earn four times their investment,” adds Kfir.
Internet and mobile apps companies require very small investments, so the cost of closing them down is small as well. On the other hand, communications, semiconductor and hardware startups require heavy investment to bring a product to the market, so that shutting them is a bigger blow to their backers.
One of the most prominent examples of that is Wisair, a RAD group company that went into receivership a year ago after some $80 million was invested in it by leading VCs and companies. The company, which employed 80 people in 2010, was developing wireless chips for short-range transmissions for the consumer market.
“The big advantage of Israel culture is they say ‘Get up on your feet and keep moving.’ When it looks bad, you look at yourself in the mirror and say, ‘So what if it’s difficult. Nothing’s really happened. We’ve passed through tough times before. We’ll get through this,’” says Alon.
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