I’ve been asked lately “what is an early exit?” It’s probably the most exciting and interesting topic for entrepreneurs and angel investors right now, so it’s worth a moment to talk about it.
First – the “exit” part. Exits are liquidity events in which angel or Venture Capital investors get their investments (and hopefully profits) out of the companies they invest in. Exits are typically M&A (mergers and acquisitions) or IPO (Initial Public Offerings). Basically, someone else is buying the company for more than the investors paid for it. The founders may stay on with the company at this point, so it’s not always an exit of the founder, or end of the company – just a return of capital to investors.
The “early” part is where it gets interesting. Most angel and VC deals can go from five to seven years or even more. “early exits” are much faster and may take only two or three years from the time of investment. The implications of an early exit are:
1) The exit can be smaller because there are likely fewer investors and less time. Smaller exits can be easier to execute. Investors calculate their returns based on IRR (Internal Rate of Return). This is a function of time and money. VC returns are typically something like 10X over five years, but if the exit is in three years, then 4X the investment is just about the same IRR, so it’s a great return.
2) The risks are reduced. It’s sometimes better to have a bird in the hand than two in the bush. Competitors can jump in, regulations can change, trends can shift and myriad other adverse situations can come to bear, resulting in negative outcomes for a company. Getting out early limits the number of bad things that can happen.
3) Don’t Ride it Over the Top. Companies that wait too long to exit, sometimes see their growth curves flatten out or even go negative. This results in much lower valuations at exit. Now, you’ve wasted several years AND you get a lower return. Better to sell out at the top or even just before.
4) Entrepreneurs can create “serial diversification”. We tell angel investors that they should be diversified into multiple deals to spread the risk. Entrepreneurs, however, have to focus on just one company. If they work with early exit deals, though, they can create serial diversification by being in and out of deals in two or three years, so they can “diversify” into three to five deals in a decade and spread out their risk.
5) Angel Investors can recycle their profits and create an evergreen fund. Rather than taking their money off the table, angel investors who focus on early exits can take their profits and reinvest in more diversified opportunities and compound their profits. Cash-on-cash returns for multiple investments can be much greater than those who invest in a single long-term deal.
Attend the Colorado Capital Conference, coming up October 12-13 in Denver, CO. We will be featuring Basil Peters, author of the book Early Exits, as Keynote speaker and we’ll have a host of great companies presenting and panels addressing early exit opportunities.
Be a part of the community and join us Monday evening, October 12 for a 30th anniversary of angel investing with RVC and a celebration of many early exits to come.
More information and registration at www.coloradocapitalconference.org