An Exit Strategy is not a ‘how to’ for retirement. An exit strategy is a plan by founders to attract early stage investors with a way investors can get their money back plus profit. The exit gives the investors the return.
Founders like starting companies. They love the excitement, seeing their business idea come to fruition and the money that typically comes with it. However, once they have hit 50 or 60 employees and have reached the limit of their management skills reality sets in. They like the process and they want to take another idea to the world – new idea and a new company! Another serial entrepreneur is born.
Investors in a start-up need a liquidity event in order to recoup their investment and make a return. Investors typically won’t wait more than five years for liquidity to happen so a pitch by a founder for money without an exit strategy will not likely get many investors.
There are six typical exit strategies for the founder to follow and some are doozies.
Merger & Acquisition (M&A)
A number of years ago it was a big thing for larger companies to buyout a smaller company in a complementary business. It made a lot of sense for the larger company to pay $20M for a young aggressive start-up that had done all the work and had developed a proven concept rather than developing their own from scratch.
It’s a win-win situation. The Bigco get a new revenue stream, the founders have proven they are a success and the investors get their return.
These days it’s more complicated with the start-up usually taking cash and shares. A friend’s company, US Cobalt, was recently acquired by a larger cobalt company and earned $150M for his investors. Everyone came out ahead on that merger.
In many hi-tech companies, the founders and some key employees will stay on for continuity and because when they finally cash out it will be at a higher pay-out. Kevin Systrom and Mike Krieger, founders of Instagram, finally resigned this week six years after Facebook bought them out for $1B in 2012.
This form of exit is a hybrid of the M&A in that the company is bought, not for the product but for the talents of its’ founder or key leaders. Sometimes the company is less valuable than the talents of the leadership and once acquired the start-up is closed and the talent remain under contract.
IPO (Initial Public Offering)
The dream of many start-up CEO’s is to ‘take their company public’ on the stock market. Going public is like reaching a major business milestone and if done correctly will make everyone wealthy.
The early investors are happy because the liquidity event means they can finally cash out and earn many times their initial investment. The risk of investing in new start-ups is mitigated by the return from the IPO.
Most start-ups will realize when the timing is right to become a public company. Fast controlled growth, good earnings and a desire to grow larger are indicators it is time to become public. People might be surprized to know that as large as these corporations are Facebook and Twitter only became public in 2012 and 2013 respectively.
IPO’s seem to be taking longer to happen because of so much early stage investment capital available to start-ups (thanks Silicon Valley angels).
Of course, with potential windfalls there are downsides to being a public company. Shareholders are certainly demanding and fickle and liabilities and compliance issues are extreme. There is also a very real chance that the inexperienced CEO may find himself with money and shares but voted out of a job by shareholders. The common story that Steve Jobs was forced to leave Apple after a power struggle with then CEO John Sculley sounded realistic but, in fact, Jobs left on his own accord because of the struggle for control.
IP (Intellectual Property)
There is no doubt that some intellectual properties are the most valuable asset of the start-up. There have been stories over the years of inventors developing car engines that would last forever being bought out by GM and then hidden in a file. How could a car company compete? I had a friend who developed concrete that was harder than steel and weighed less than average cement. He ‘disappeared in the 1970’s. I hope he is living the high life on a beach but you never know.
The point is there are exit strategies that include selling the IP of the company and not looking back. Current valuations when looking for start-up capital put a value of around 30-40% on the IP. It gets a lot higher when the IP is a proven winner.
The last two strategies involve a cow!
Milking the Cow
Many of the start-ups I work with are bootstrapped meaning they keep their overhead (burn-rate) low and self fund the business or use family and friends to finance the operation.
Not every company needs to sell the company to grow or earn money. Some companies actually gross large earnings quickly (unlike some social media platforms that took forever to generate revenue).
With a well-defined business model and good upward trending revenue a start-up can provide dividends to their investors therefore keeping them motivated from demanding a liquidity event.
I’ve seen a successful start-up founder sell his company to a friendly buyer who had the same mission and passion as the founder. The founder didn’t take a massive cash pay-out he took a sizable royalty (that the company could afford) which gave him a steady revenue and enough money to start his next venture.
There are many considerations that come into play when considering the exit. Not every company can manage an exit that is beneficial to everyone. Sometimes it makes more sense to sell when the company has a reasonable evaluation than waiting for the big score.
Consider the scenario of selling the company at $30M with a few investors having put only $2M in the funding versus the $250M merger with many rounds of investors, angels and institutions who have worked diligently to dilute your founder shares to peanuts.
Optimizing a good opportunity is better than getting out of a bad one.
To the young start-up founder remember that investors will look for the exit at your investor pitch session – don’t disappoint them!
Gary is CEO of the Bizzo Management Group Inc. specializing in start-ups with innovative technologies. He is a global social media influencer and loves investor relations.