As a startup entrepreneur, you are mostly thinking about how to survive and getting to the next milestone next week or next month. And then an investor inevitably asks you, “what are your most likely exit opportunities?”
Your first thought is “why the heck is that even close to a relevant question for me to think about right now?” It feels so far away … kind of like asking you what you’re going to do when you retire. Not something you’re spending a lot of time thinking about.
Most investors answer to other investors
Except for a few investors who are investing their own personal money, almost all institutional investors have a contractual obligation to return cash to the investors who’ve invested in their fund. They’ve typically committed to return investor money within a certain timeframe and to achieve certain financial return results for the fund. Since most funds are investing in multiple businesses, they have the added complication of needing to estimate exit timings of their various investments to meet an overall objective. Similarly, they are needing to reach a blended targeted financial return across their portfolio.
Exit timing and rates of return are related
Here are two scenarios illustrating how exit timing and financial rates of return are related:
- Scenario 1: Fund invests $100 in a business on day 1 and has an exit 3 years later of $200. The IRR is 26%.
- Scenario 2: Fund invests $100 in a business on day 1 and has an exit 5 years later of $200. The IRR is 15%.
Because there is opportunity cost for money being tied up longer, a later exit at the same value has a lower return for investors.
Here are the typical exit possibilities that might be considered:
- Strategic sale to another company – statistically the most common
- Management buyout – management team arranges resources to buy out investors
- Secondary sale to another investor – typically by private equity firms
- Company buyback – the company buys back shares from investors
- Initial public offering – what most investors dream of, but rarely happens
Exit most likely probabilities
What’s most productive is to pick a few of the more likely exit scenarios and describe to investor what they might look like and why. A few ideas:
- Name a few companies who would be interested in buying your company if you could get to a certain operational size (or market share.) They to include some not so obvious companies in your list to demonstrate you’re actually thinking about this.
- What is going to make your company interesting to buy? How could it be put together with other assets, teams, resources, etc. to be worth more to someone else than it is worth to you staying independent?
- What are the market trends — e.g. demographic shifts, government policy, emerging opportunities, technology adoption, etc. — which make your company an interesting acquisition?
Test your operational goals and strategies against your exit scenarios
As you develop your shorter term goals, ask yourself the question — how do these goals increase the attractiveness of your company to a potential acquirer? Often the things that are attractive to an acquirer are also things that continue to improve your business’ long-term durability such as continuing to build your competitive advantage or increasing your low cost leadership. It doesn’t mean that you are trying to immediately sell your business, but it’s a good exercise to go through.
And then go back to your main focus which is operating your business with excellence to achieve your strategic objectives.