This week, I had a really fascinating conversation with a portfolio founder named Joshua Lee, who’s the CEO and co-founder of a company called Ardius. Ardius helps startups claim R&D tax credits. So it’s a no-brainer why founders sign up for Ardius, because they can get free money, and Ardius takes a cut of what they are able to help founders get. If they can’t help you get any credits, they don’t get paid.
But what was fascinating was that when I was talking with Joshua, he said that one of his learnings in trying so many startups over the years, was that founders don’t think enough about their exit path before starting a company. Ardius, in fact, was not his first company, and so after many companies that didn’t work out, he decided to work backwards to figure out what to build.
I asked him, well, what do you mean?
He said that when he started Ardius, he not only talked with potential customers, but also talked with potential competitors – large companies who could potentially be building a competing product on their own. He was trying to see if he could manufacture his own exit before starting Ardius. He wanted to know what the M&A appetite would be if he were successful. He wanted to know how big of an opportunity large companies saw in what he was building.
And I asked “wasn’t that kind of dangerous to talk to companies that would potentially be building the same thing?” And he said, when he talked with a lot of the major players in the HR benefits space, in fact, many of them were building a competitor to Ardius. And some of them even told him they would squash his company.
While that was frightening to him, his thesis was that if you’re good, startups are actually way scrappier, faster, and more specialized and can run circles around most large companies. And as it would turn out, he was able to plant seeds in their heads that in case they were not happy with their own progress, they should stay in touch.
Ardius ended up doing quite well as an independent entity. And that caught the eye of all of these would-be competitors. Fast forward, Ardius was acquired by Gusto in 2021 after discussing with all the major players in the HR benefits space. These were relationships Joshua had already been building for years, which made the acquisition process quite smooth.
Now this whole story is a pretty controversial path. Many venture capitalists wouldn’t like this path, because VCs would prefer companies to keep raising money if it makes sense to continue to swing for a larger exit. After all, VCs need their winners to be large enough to above and beyond overcome the losses of portfolio companies who fail.
But, Joshua’s view is that VCs should think about the faster liquidity they could get with a manufactured exit. Instead of waiting 15 years to get to 100x (or more), would you rather wait 5 years and take a 10x? He thinks the idea that you have to wait a long time for liquidity in venture is outdated. From an IRR perspective, his model is also way better. In fact, in this particular example, the IRR of the longer time period is 36% vs 58% for the shorter time period.
Not to mention that we didn’t talk about how with his model, the team isn’t grinding too long to lead to burn out. Nor does the team become too big and chaotic, as you often see at large fast-growth late stage startups.
His argument certainly made sense to me. Certainly, if you were running your own angel investments, his proposed model is intriguing. You get your money back sooner, and you can redeploy sooner into other investments.
But, it made me think why this doesn’t work in the traditional VC model. VCs are judged on multiples returned as liquid cash over the term of the fund. Typically funds have a 10 year lifespan. So in this model, the winners aren’t around long enough to become huge winners. And yet, if you’re getting money back in year 5, you don’t have enough time either to deploy the returned capital back into new startups. So, the cash is just sorta stuck — either doing follow on checks into later stage companies, which tend to have lower multiples than early stage startups OR it just gets returned as cash and isn’t enough cash to make up for many of the portfolio losses. In other words, this model — assuming it works — works really well in an evergreen fund but not in a fund with a set term limit of 10 years.
All of that said, his model of building relationships with potential partners / acquirers / competitors from day 1 is smart — even if you aren’t looking to get acquired right away. One of my other portfolio founders did something similar, not for the purpose of M&A, but for the purpose of building relationships and ended up getting acquired by essentially a would-be competitor, because she had built those relationships early.
It may be scary talking with potential competitors – especially when you have nothing – but if you truly believe that your startup is great, you can outcompete your competition. As we’ve seen time and again, more funding does not equate to more success.
One thing that I am skeptical of in this model is the notion that you can actually predict what will be acquired. And therefore, your loss ratio is lower. Afterall, one of the hardest parts about building a startup is finding a repeatable sales process and enough customers who want to pay for your product. M&A demand is predicated on the assumption that your product will find very strong product-market fit. If you are able to find customers but only slowly, your would-be acquirers might decide that there isn’t enough demand for your idea. And, you might not be able to manufacture the M&A deal you thought existed when you set out to begin your company. In other words, I’m skeptical that you can come up with a higher batting average of ideas that are successful that companies will want to buy than the traditional VC model.
I always learn a lot from my portfolio founders, and this model of building-for-exits is certainly food for thought.
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