Since When Is 3x a Good VC Return?

Maybe the VC model is broken after all.

The VCs who backed hot digital video recorder maker Pure Digital Technologies Inc. have agreed to sell the company to Cisco Systems for $590 million in stock. At first, it sounds like a pretty good deal, but you have to understand that the VCs put $95 million into Pure, which makes the Flip digital video camera. Assuming they own half of the company, that’s a return of just over 3x their money. For a middle-of-the road VC firm, that would be a decent return, but for big name backers Benchmark Capital and Sequoia Captial that’s pretty much a dud.

Firms like Benchmark and Sequoia (and, more importantly, their limited partners) look for a minimum return of 10x on a deal. You also have to factor in that both Benchmark and Sequoia were in the $13 million Series A round for Pure in May 2004, so that means they put in five years of work for 3x.

This is the clearest sign yet that venture firms don’t expect the IPO market to come back for a long time. Pure’s CEO reportedly said the company will be profitable this quarter. If that’s the case, then there would be no need for the VCs to rush to exit. Unless, of course, they don’t believe the IPO market will come back in a serious way until after next year.

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  • Let me play devil’s advocate: Is a 3x return better on a $95m investment than a 10x return on an $8m investment? Or not, because what you really want is 10x return on four $8m investments, and the rest can wash out?

  • VCs don’t care so much about the multiple. They care about the amount of money returned. Assuming there was a 3x on the money invested, this means some $200m net profit.

    Talk to some VCs out there. That is a very decent amount of money. Very few would refuse to bank that.

  • I’ve got no knowledge of the specifics of this deal, but once $95M is into a deal, you can be pretty sure that the VC’s own 70-80% of the company. So, the VC’s probably took at least $440M of the exit value. It’s still about a 4.5x, so your sentiment may be right in the aggregate. But, the early investors may have done better than that because they probably had a lower average share price than the later stage investors.

  • It’s because of the terms of these deals.

  • Jens, I think you’re right that this would be a good deal for most VCs, especially in this exit environment. I just can’t tell you how many times over the years that brand name VCs like Benchmark have told me that they won’t even consider a deal that doesn’t have a 10x potential. And when you look at the amount of money they have under management, 3x or even 4.5x returns just aren’t going to get the job done for them. I’d be really curious to hear from an LP in either Benchmark or Sequoia. Are you happy with this deal?

  • Larry, you are somewhat misinterpreting the “10x” remark. I’m sure that the Series A investors sold the stock to Cisco for more than 10x the Series A price. They try to make 10x on their first money in, not 10x on all the follow-on dollars. I bet they achieved that here.

  • [...] may all have ended up with healthy multiples on their [...]

  • Sequoia has raised $3.2 billion over the past three years. How many Pure Digital deals do you need to have to make that money back?

  • Hence my subprime VC blog, where as I stated before, these returns cannot build the returns for $100M+ funds. For some of the VCs on the board the vintage and total return probably produces a vote to sell (if they made their target, why fight hard on this one in this economy). Maybe the other investors just got dragged along in the decision, a reason why piggy-backing on Sequioa (like Crescendo has done a few times recently) is not good for the lesser endowed.

  • Technically, VC’s look to make a large return on their portfolio, not a specific investment. In any case, given this case, this seems like a good deal.

  • Every VC will say they “target” 10x (and say other things like “proprietary deal flow”) but they don’t really expect to achieve that. Even in good times how many opportunities are there to 10x a $100MM investment into a $1BB exit? Smaller, earlier stage funds might have this opportunity… but get ready to wait 10-12 years to see the returns.

  • Let’s not forget liquidation preferences. There’s a good chance that in the end VC’s might have gotten a good 80+% of that $590M!

  • [...] that Cisco paid $590mm (in stock) for Pure Digital the maker of the super popular Flip Cam to ask this question: it sounds like a pretty good deal, but you have to understand that the VCs put $95 million into [...]

  • [...] synes at betragte det som en succes for Pure Digital Technologies at blive solgt. Det andet er, at nogen synes, at det er for dÃ¥rligt, at venturefirmaerne kun fÃ¥r 3 gange deres indskud for: 10 gange [...]

  • Valuation and return aside, this company probably owns some interesting technology and related IP that can be turned into something. Market share will probably be challenged by the fact that almost any cell fone can do the same thing. Personal experience with the company has shown me they have somewhat of a customer service problem, as well.

  • [...] Digital Technologies? Published March 20, 2009 Venture Capital peHUB has a really interesting post up about how venture capitalists did with selling Pure, the maker of the Flip camcorder, to Cisco. At [...]

  • Also, it is not a “cash” deal, VC will own shares of Cisco and there is probably a lock-up period….
    Anyway, shares of Cisco today might be cheap but they might still go down for a year…

  • You’re also missing the fact that this is potentially to help their LP’s who you’ve spilled much ink over who might be encountering capital / liquidity shortages themselves. If Sequoia just returned $220M in Cisco stock (almost as good as cash) and they make another capital call for their next deal and Crescendo or someone like that who hasn’t returned capital on their funds at all whose capital call would you answer first? Obviously both from a legal standpoint but from a true altruistic standpoint use your head.

  • I think that VCs expect a 10x return on VC investments GOING INTO the deal to account for the duds. In other words, the return threshold should be 10x. When the actual return is 3x over 5 years, I think most VCs and LPs would accept that. It’s not quite a home run, but nothing to scoff at either.

  • Sorry Scott, Howard,

    I’m probably having a stupid moment, but could you explain what you mean by: “expect a 10x return on VC investments GOING INTO the deal… the return threshold should be 10x”; and “I’m sure that the Series A investors sold the stock to Cisco for more than 10x the Series A price… They try to make 10x on their first money in”

    in the latter quote, do you mean that the Series A investors may have paid a much lower share price but that the later investors would have paid much higher? ie the 3x multiple represents the average return for all the equity investors?

    Thanks very much!

  • @Simon If i’m the scott your meant (there were a couple), here’s a simplistic version of what I meant:

    Series A investment at $1 per share, the first time that VCs get involved.
    Series B investment @ $3.33 per share, where there are some new VCs but the original ones also put in add’l money at the $3.33 price. That’s called “exercising their pro rata.” Let’s speculate that the original VCs average price is now $2 per share.

    Sale of Company at $10 per share. The original VCs makes 10x on their original shares, 3x on their pro rata shares in the Series B and 5x overall. This satisfies the stultifying rhetoric of “make 10x our money.”

  • Thanks Scott for taking the time to clarify that! BR.

  • very clearly scott’s explanation makes sense. different VCs go into a deal for different expected outcomes. benchmark and sequoia are earlier stage investors, and they’ve returned spectacularly on this exit. later stage investors are taking on less risk and are moving into each deal fully aware of the risk/reward tradeoff involved.

  • I think people have sufficiently covered the 10x potential on this exit.

    The devil is in the details however. Without seeing the term sheets and the valuations at which the fundings were made, it is impossible to figure the return. Based upon the investors coming into the deal in 2007 I am sure it was a nice up-round at a 250-350M pre. Since Sequoia was in at the seed level and Benchmark at a Series A with a ballpark 30-40M pre I think it is safe to say that our two friends were easily in the 6-8 times money ballpark. 6-8x is an amazing return in these times and a very good one in better economic times.

  • [...] that Cisco paid $590mm (in stock) for Pure Digital the maker of the super popular Flip Cam to ask this question. it sounds like a pretty good deal, but you have to understand that the VCs put $95 million into [...]

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