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Almost every founder I talk to is thinking about their “exit” from nearly the beginning.
Angel investors frequently ask “what’s your exit strategy?”
And at the seed and Series A stages, often founders talk about their exit strategy unprompted.
I think that’s a mistake.
Early on you should be focused on building a big and impactful company and dominating
your market.
Do that and the right monetization event will come along.
But from the beginning, it’s important to understand how exits work and what possible
outcomes may look like.
Most first-time founders don’t realize how, when, and why common exit scenarios unfold.
So let’s cover the primary ways an exit can occur, why and when they occur, and how
to maximize exit opportunity value for you, your investors, and your team.
Alright, we have a lot of ground to cover.
I want to talk about acquisitions, how companies are bought not sold, acqui-hires, IPO’s
(or SPAC’s), exit dynamics when bootstrapped versus venture-backed, some M&A deal terms
to think about, and in acquisitions where most buyers come from.
Let’s start off with an important statistic -- with venture-backed companies, for startups
that reach some form of monetization event, over 90% will be acquired and few will go
public.
So let’s start by digging into acquisitions, how they work, and what to keep in mind.
The first thing to know is the M&A mantra that “companies are bought, not sold.”
What does that mean?
To maximize value for you, your team, and investors, the best deal you are going to
get is when an acquirer starts pursuing you -- AKA you are being “bought.”
They open up a dialogue along the lines of “we’d love to talk to you about possibly
acquiring your company.”
The inverse of being “bought” is where you go out to “sell” your company.
If you are a startup that wants to hire a banker and put a “process” together to
“sell” your company, typically, you won’t get nearly the premium.
There is the blend if someone says they want to acquire you and you decide to then “play
the field” and see if you can get other companies interested and get a bidding war
going.
If you can, that’s great as hopefully, you’ll get better terms.
But again, keep in mind that in the best case startups are, for the most part, bought, not
sold.
The main time I see startups being “sold” is where it’s some form of “fire sale,”
things are not working out… and the startup or investors are trying to recoop whatever
cash they can and want to possibly find the team a new home.
So since we said the best type of acquisition is when you are pursued, let’s talk about
where these buyers come from.
Where do you find them or where and how do they find you?
We see that in most cases when a startup gets an acquisition offer, it comes from a company
they already know and have some type of relationship with.
Maybe it’s a co-development partner, strategic funding source, integration partner, channel,
or distribution partner.
Often, they’ve worked with you for quite some time, see that you have something meaningful,
and realize there is a more potential if they own you.
Sometimes you do get approached by someone you’ve never met before -- it can happen.
But it’s rare.
What’s important to keep in mind if someone is talking to you about an acquisition, is
the deal dynamics will be different if you bootstrapped versus taken a lot of outside
funding.
With a lot of outside funding in your company, the more cash you take, the fewer exit options
you’ll have.
As you take in more investor cash, the “exit hurdle” grows substantially.
Think about it.
If you take in $1m in outside funding, there are hundreds of companies that could acquire
you at an amount that would provide a great return for the founders and investors.
But as you take in $10m, $50m, $100m, or more, there are fewer and fewer companies that can
afford to acquire you and provide a return that venture investors, and you, would find
materially interesting and provide for a high ROI on funds invested.
As a founder, remember that if a VC puts money into your startup, it’s because investors
want to back the “next big thing” and they want you to “go big or go home.”
Let’s say you’ve raised $2m from outside investors and for that, they own 20% of your
company (so you are probably at a $10m-$12m post-money valuation).
Someone comes along and wants to buy you for $10m.
Let’s say you still own 30% of your startup and you do very simple math (not remembering
the exact terms of your deal) and think “awesome, I could walk away with $3m.”
But your investor is thinking “I just put money in at that valuation… so I’m basically
only getting my money back.”
For most investors, that’s not interesting as they’re typically looking to make 3x
or more in the very high risk world of startup investing.
I’ve seen investors, on more than one occasion, say “Look, I think you shouldn’t sell
but instead keep going.
Build the company and let’s make it into something huge.”
Remember, the more venture money you take in, the more options you take off the table
for an early exit that may be meaningful to you, but not to others.
Next up, I want to talk about a very common type of exit that many don’t realize when
it happens -- and that’s the “soft landing”, “rescue” or “aqqui-hire” exit.
When the startup has been going for some time and usually after substantial investor funds
have been consumed, but insufficient traction and market penetration have occurred, frequently
startups or investors will start looking for a “soft landing” for the startup.
This is for several reasons…
The investors are looking to get at least some cash back out of the startup… the investor
and founders are trying to find a “home” for their team so everyone has a job… and
also everyone is trying to see if they can somehow monetize the IP and customer base.
When you read the news of a startup being acquired, and you see the wording “terms
not disclosed,” that’s often a tell that a soft landing or aqui-hire has occurred.
Usually not a great outcome.
But look -- it’s part of being an entrepreneur and startup investor.
Sometimes deals and companies don’t work out and you’re trying to get the best possible
outcome for all.
A final note about being acquired before we talk about being a public company.
If you get an acquisition offer, make sure to surround yourself with a great team of
trusted advisors -- your Board, investors, law firm, accounting firm, and hopefully other
trusted entrepreneurs who have been acquired.
Structuring and hammering out a great deal is not easy and is a team sport.
Most entrepreneurs don’t have a lot of experience in M&A deals and there are a ton of critical
tricks and traps to navigating the due diligence process, earnout agreements, deal structuring,
price and consideration, tax consequences, escrows, holdbacks, reps and warranties, and
dozens of more issues.
Do your homework!
Also, if you are VC backed, suddenly your cap table and the terms of your “capital
stack” are going to come into sharp focus as you figure out, with all of the preferences
and rights, who exactly gets what.
Bring your A team and A game to this process.
Okay, now the final type of “startup exit” to talk about is being a public company.
Maybe you IPO, reverse merge into a public shell or do a deal with a special purpose
acquisition company or SPAC.
Being a public company can be great as it can, after a lock-up period, provide liquidity
to founders, investors, and early hires who have stock options.
Being public does carry heavy administrative and organizational costs and now you need
to act a lot more “buttoned-up,”.
As well, you can access very large pools of capital to continue fueling your growth.
One other great impact is from a branding and marketing point of view.
Being public adds a level of credibility to your company and brand awareness.
Again, exiting by going or being public happens infrequently to startups as the M&A path is
most likely.
I hope you found this overview of how startup exits work helpful.
It’s good info to keep in the back of your mind and hopefully you’ll get there one
day.
But remember, keep your eye on the prize -- building a great company that dominates your industry.
Do that and the right exit opportunities will arise.
I hope you liked this video and if you did, please like and subscribe to the Slidebean
and Dreamit Ventures YouTube channels.
Thanks for watching!