I’ve been talking to a lot of people about exit strategies this year, including VCs, Investment Bankers, two and three time exit participants, entrepreneurs and investors. I’ve heard a lot of great exit stories and yet there doesn’t seem to be a consensus about when a company should begin planning for its exit.
One school of thought is that you should just start a company and grow it as fast as possible and you’ll know when it’s time to exit. This has been described kind of like lightning striking and then it’s time.
The problem with this school of thought it that it is all wrong.
Companies should be thinking about their exit plan before they even form the company.
Here are a few reasons:
1) It’s an agreed upon principle that a company should really know its customer. If you’re selling widgets through your company, you need to know the widget buyers, but if you’re eventually going to be selling the company, pursuing an IPO or other exit, you need to know your customer – and it’s not the guy who buys your widgets – it’s the company that acquires you. You need to know why your company would be a strategic advantage for them – would you provide a geographic benefit? A new set of clients? Intellectual Property? Or would they buy you just to get rid of a meddlesome competitor? You need to know who will acquire you and why they want to acquire you. Once you know that, then you build the company to provide the most value to the people who will buy it.
2) Exits aren’t executed in a day. By the time that you realize it’s time to exit, it’s probably too late to put a plan together and get it done. Smart companies plan for their exits and understand acquisitions in their field and structure their company so that multiple companies will be likely to be bidding for it when the time comes. If you spend your time building a company that has only one potential acquirer do you think you’ll get top dollar? A great exit is built on relationships. These can take months and years to cultivate, especially among multiple acquirers. Why not begin those relationships at the start and shorten the time to exit?
3) Understanding exits is the key to understanding company value. Many valuation methodologies for early stage companies are based on the exit value. The Venture Capital Method begins with potential exit scenarios and then discounts the value of those exits to present value. If the company can’t develop a strong case for a big exit, they will either fail to raise venture capital, or they may raise capital at valuations far lower than their potential. Early stage companies should research who is acquiring whom in their market and for how much. This research will make them much more attractive to investors who know that without an exit, they will never get their money back.
4) I recently worked with a company that set up several subsidiary companies with different ownership structures and potential conflicts of interest among them. This could make sense in terms of building an international distribution business, but it makes no sense to potential acquirers. Ultimately this strategy would lead to much lower acquisition price in the end. If you think about the exit when you’re setting up your company, your decisions will be easier since you can just ask yourself “what will add the most value to an acquirer?”
5) Finally, there’s Steven Covey’s second Habit of Highly Successful People “Begin with the end in mind.” Do you think he meant this for everything except something as important as the destiny for your company? No, you need to found your company with the idea that there will be an exit and a clear idea of who will acquire it. Without this clarity, the company will be spinning its wheels on initiatives that may not ultimately be adding value to the acquirer. Some people say that you can’t know for sure who will acquire you when you’re just starting out. Sure – that’s true. But the fact is that you can’t know ANYTHING for sure, so if you can only plan for things you know for sure, the only sure thing is that you shouldn’t be planning on being an entrepreneur. I’ve heard the same arguments from people that entrepreneurs shouldn’t even bother with a business plan – just do it, they say. This is a pendulum-swing response to those who are stuck with analysis-paralysis which is also a company killer. Neither extreme is good. These people are sometimes lucky, but more often not, they’re forming part of the 90% of businesses that fail. All investors and entrepreneurs should know that their plans are not likely to be executed as stated, but this doesn’t mean that there shouldn’t be a plan. Without a plan, there is no alignment among team members, no goal, no smart thinking about options and alternatives, and all you’ve got going for you is luck. Good luck with that.
To learn more about exits and learn from some of the biggest exits in Colorado, attend the Colorado Capital Conference November 6-7 and hear about seven big exits and how they happened. You’ll also get to see twelve great startup pitches, all of which have a clear exit strategy articulated! Join us and follow the debate!
Register now at www.coloradocapitalconference.org