VCs: Can't see an IPO or acquisition for your startup? Don't throw in the towel

Comment There surely must be an alternative to the two preferred exits for VC-backed startups – IPO or acquisition – in these times of near-VC funding drought and what seems like IPO fatigue.

It used to be simple: build a storage startup that could take money and customers from the mainstream vendors, sit back and wait for competitors to come running with open wallets or bankers singing songs of IPO riches.

Acquisition was more certain and we have seen round after round of acquisitions. In no particular order: EqualLogic, 3PAR, Compellent, Data Domain, CleverSafe, Storwize, TMS, XtremIO, DSSD, SolidFire, and many more.

IPOs in the storage space have been fewer, and many have been problematic. Violin Memory is still fighting the problems that came with it to its IPO. Nimble Storage has had its hiccup. Pure Storage still has everything to prove and has had a mini-hiccup. Nexsan tried and tried again for an IPO and was eventually acquired by Imation, where it is now the core product line. Nutanix has filed for an IPO but delayed it.

Why is the storage IPO scene such a troubled one?

Acquisition blues

Before we have a stab at answering that, let's also note that the acquisition scene is changing, with fewer mainstream storage acquirers and more potential acquirees. The hyper-converged space is illustrative of this, with some 30-plus companies shooting for glory in the market and all the mainstream storage vendors, except NetApp, with their own in-house or OEM'd hyper-converged product line.

The conclusion seems inescapable: most hyper-converged startups will not get bought and their chances of an IPO are as remote as Richard Nixon becoming US president again.

The hybrid array space is another example. All the mainstream vendors have their own hybrid flash and disk arrays, meaning Pivot, Tegile and Tintri have few prospects of getting acquired and their IPO chances look thin too.

IPO problems

The IPO scene for storage companies is troubled because they basically lose shareholder value after an IPO – like a new car suffering an instant depreciation hit immediately after purchase. Buying shares in an IPO'ing storage company is only for mugs, people playing a long game, looking 5+ years out, or for day trader junkies.

You can argue that the problem is because storage startups IPO too early; well before they establish themselves. But they are VC-backed, and venture capitalists want a golden exit fuelled by investor/gamblers greams of getting in at ground level to a super-growth stock. When that growth stumbles the stock is punished. Witness Violin at the harsh end of that spectrum and Nimble at the gentler end.

Loss-making Pure's stock valuation is held up by dreams of super-growth, and it has to keep those dreams alive, while growing fast enough and controlling cash burn and costs to show profitabilty is a real prospect, and expanding its product line successfully so that it can actually reach the sunny uplands of profitability.

Pure, Nimble and, hopefully, Nutanix, in all-flash and hybrid arrays and hyper-converged appliances, are the outliers. What happens to the rest of the startups in those and other categories?

Their VCs want their golden exit too and yet, in the cold and long nights when they can think clearly, must know that they maybe bet on the wrong horses for that.

What do they do?

Change to long-term ownership

Tell their startup serf companies to cut cash burn for a start. We see rounds of small-scale layoffs as evidence of this – think Data Gravity, Atlantis and others. But this is mere Titanic deck chair re-arranging while hoping the iceberg doesn't strike. Suppose it does? What then?

Suppose they have to face up to the fact that their investments in companies like ExaGrid, GridStore, Maxta, Nexenta, Pivot3, Tegile, Tintri, Zerto and many others are becoming highly unlikely to deliver the golden exit they want in the next 2-5 years. They can pull as much of their money out as possible, which probably means killing the company, or they could change the mindset to one of owning a company for the medium (5+ years) or long haul, growing it to profitability and taking dividends and/or loan repayments to get an income stream from it.

VCs are not set up to do this. Some private equity firms are. Possibly we will see VC-backed firms, that could be successful privately-owned businesses - think DataCore - or even Dell - being sold to private-equity backers to provide the longer-term and stable ownership environment needed for the firms' execs to convert the company from a fast growth strategy, to fuel VCs hopes, to one of steady growth to profitability and then sustainable operations after that.

Life as a public company can be a pain in the corporate neck – just ask Michael Dell, or Kevin DeNuccio at Violin. There is a lot to be said for stable private ownership, and freedom from the herd instinct tantrums of day traders and other investors driven into trading activity by analysts.

It would be a tragedy if potentially viable companies with great technology and good products, the Tegiles, Tintris, Nutanixes, etc of our storage world stumbled and died because short-term VCs can see neither IPO nor mainstream vendor acquisition in their startup's futures, and throw in the towel. There has to be a third way^*. ®

* Perhaps someone will set up a private equity fund to buy distressed storage startups?