ELI5- When a company IPOs, isn’t it at the point that VCs have already extracted all the value, and they’re cashing out? Do they have to hold?
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A startup is a company that, in a short time, goes from being worth about nothing to either being worth nothing at all (in most cases) or being worth quite something.
VCs specialize in investing in such companies, because although the risk of losing your investment is quite high, the reward if it does not pays for it.
Once the company is worth quite something, the growth to being worth even more is much more probable, but the factor by which the company grows will never be that high.
So for a VC willing to risk losing the money completely, it is better to pull out the money and invest it in more companies being worth about nothing.
The key concept here is _opportunity cost_. The opportunity cost of doing a thing is the potential reward from doing _something else_ that one misses by doing this thing.
Normally the VCs do not cash out the value of the company. All the revenue of the company is typically fed back into the company to increase its value, it is not paid out as dividend to the VC. The way a VC cash out is by selling their shares to someone else now that the company is worth so much more then when the VC invested in it. An IPO is a way of helping the VC do this and prepare for the VC to cash out. It is much easier for the VC to find buyers if the company is public. So the IPO typically comes when the VC have increased the value of the company as much as they can or want.
Not necessarily. VCs may use the IPO to cash out some, but may also hold onto shares if they still believe in the ling term prospects of the company. Maybe by time of IPO they’ve made 20x their initial investment, so they sell enough to take their initial investment off the table, and perhaps some more on top of that while still keeping a substantial chunk of their equity in the company. They’d want to free up cash to invest in new companies, but an IPO is by no means an end to the run up in value of the company. And their investment now being public they can easily sell at any time in the future should they decide it’s time to do so.
I think you’re thinking of Private Equity (PE) rather than Venture Capital (VC).
When a VC invests, it’s typically in a growing company that needs resources to mature. VCs give them resources in trade for ownership. As the company grows it becomes more valuable. In an IPO, the VC sells its ownership stake in the now more valuable company and “cashes out.”
When a PE firm invests, it’s typically in a mature company that is possibly distressed. The PE firm buys the company and its assets on the cheap with a plan to “cash out” the company in some fixed number of years. This definitive and short term approach often means the PE sells off assets for short term gain, restructures or adds debt to the owned company, and pursues business strategies that make the company look better within the transaction timeframe but may very well be long-term damaging.
Typically VC’s would cash out after the IPO. The idea being that hopefully the market values the shares at a higher rate than the current shareholders do and they’ll be able to cash out and go do another VC deal.
Over time, the company hopes to grow and become more valuable for the shareholders. However, this is less risky than investing in venture capital. Venture capitalists are ok with the higher risk profile of a start up company. The average shareholder is not.
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