By Fred Wilson
FORTUNE -- Early stage venture capital is a lot like baseball: If you get a hit one out of every three times, you are headed to the Hall of Fame. And if I look back over my career, and also over the track records of the firms and funds I have helped manage, that is pretty much the hit rate I have seen. By "hit" I mean an investment that returns 5x or better. But of course, many of these hits return 10x or even 100x every once in a while.
So what happens with the other two-thirds? Well that is the part of the startup world that we don't talk too much about. Sometimes an entrepreneur will take an early exit. They will have raised a small amount of outside money, will still control the company, and will get an offer they can't refuse and take it. That's a win for the entrepreneur but not for the VC. But it is a happy outcome for everyone anyway. That's maybe 10% of the total outcomes. So at least 50% of the outcomes are not a win for the VC or the entrepreneur.
So what happens when things don't work out? There are generally two scenarios.
The first is the "slog it out" scenario. This one is in many ways the most painful. It means that there is a business that can be built, but it won't be one that makes the VCs much money, and because it takes so much time and money to "slog it out," it doesn't make the entrepreneur much money either. And in many cases, the entrepreneur chooses to leave, and the company has to recruit outside management to operate the business.
In the "slog it out" scenario, the VCs are often left holding the bag. They have a lot invested in the business and have a responsibility to figure out how to get it out. In some cases, the entrepreneur sticks around and slogs it out along with the VCs. I have great admiration for the entrepreneurs I have worked with who have slogged it out. There is very little upside for them in this scenario. Mostly they do it out of a sense of responsibility. These "slog it out" businesses can go on for a long time. I am involved with some that are well into their second decade, and I am afraid that they may be headed into a third decade.
I have heard these kinds of companies called "zombie companies" and "the living dead." That's a bit unfair, because there is no way a company can operate for two or three decades without being able to sustain itself. VCs do not keep pouring money into these businesses, maybe they do that for the first five years, but not after that. These "slog it out" companies turn into real companies eventually but just not companies that have the growth trajectories or strategic profiles that make them great acquisitions.
The second scenario is "hit the wall." In this scenario, the company runs out of cash, and there is no more coming from the investors. The company cannot sustain itself and one of two things happens. There is a fire sale or an acqui-hire, or there is a shutdown.
The fire sale is the preferred outcome, and VCs and entrepreneurs have gotten pretty good at finding homes for the teams in recent years. There is such a vacuum of talent out there that a fire sale can often be arranged just for the talent that a company has assembled. But often the fire sale cannot be arranged, and the company has to be shut down. Again, the responsibility for an orderly shut down often falls onto the VCs to manage. In a shut down, the employees must be notified and paid through the date of the shut down. All required tax payments must be made. Liabilities such as leases and bank borrowings must be managed. In particularly messy situations, a bankruptcy filing is required.
There are two interesting things here that I always think about. The first is that even the very best investors in the VC business only get a hit about 1/3 of the time. That means that they have their share of "slog it outs" and "hit the walls" too. I am certainly in that camp. The second is that we end up spending an incredible amount of time and energy (hopefully not money) on the 2/3 of our investments that don't work out. When everything goes well, you really don't need that much from a VC.
Of course, I have added value in all of my winners. But its the ones that don't work that I have left my blood, sweat, and tears on. And that's the paradox of being a VC that cares. Which is the only kind of VC you want to work with.
Why can't Fred Wilson find a new startup to back?
FORTUNE -- Fred Wilson is the best-known venture capitalist east of San Hill Road, thanks to both his wildly-popular blog and early investments in such companies as Etsy, Foursquare, Twitter and Zynga (ZNGA). But in 2012, Wilson hasn't done a single deal.
Don't get me wrong: Wilson's firm, Union Square Ventures, has made plenty of investments over the past 12 months. In MOREDan Primack - Dec 10, 2012 2:50 PM ET
Venture capital isn't about holding public stocks like Facebook.
By Fred Wilson, contributor
There is a lot of sturm und drang out there in the worlds of social media, financial media and just plain media about all the lockups coming off and all the insider selling going on in some big Internet stocks. As someone who has played this game a few times, I thought I'd post some thoughts about this.
First and MOREAug 21, 2012 1:18 PM ET
Is a Web startup's video plea for funding a sign of the bubble, or just clever marketing?
Mick Hagen is a serial entrepreneur, having recently sold his first company to textbook rental Chegg. Now he's back with a new company called Undrip, which promises to optimize social media consumption.
But Undrip isn't making waves this week because of its ability to find signals within the social media noise. It's because Hagen and MOREDan Primack - Nov 18, 2011 11:50 AM ET
The CEO of Buddy Media analyzes his recent $28 million financing and offers 8 lessons for how to thrive in a fundraise.
By Michael Lazerow, contributor
The venture capital ecosystem is a hall of secrets. The rise of the venture capital blogger, notably Union Square Venture's Fred Wilson, entrepreneur-turned-VC Mark Suster and Foundry Group's Brad Feld, is a welcome first step in providing budding entrepreneurs a view into the venture world. MOREDec 5, 2010 8:13 AM ET
Fred Wilson yesterday wrote about the concept of "chasing returns." That might sound like a noble -- or defining -- job of professional investors, but Wilson uses the phrase derisively. Specifically, he is referring to folks who plug money into "hot" sectors they don't fully understand. Think certain (most?) investment banks during the CDO boom.
The latest iteration, Wilson says, revolves around early-stage Web services investing.
Now we've heard this concern before – MOREDan Primack - Nov 29, 2010 10:35 AM ET
By Fred Wilson, contributor
Most people assume that price is what matters most in a financial transaction. When you are raising money, you want to get the money at the highest price (least dilution). When you are selling, you want to get the highest price for your company. But that is not always the case.
Price matters, but my experience says that it often does not matter the most. In many of MOREOct 25, 2010 10:55 AM ET
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