When we work with start-ups and SMEs, we always ask the exit questions. Have you planned one? Should you? When? Whom? Etc. That is why I picked up “Exit Path: How to Win the Start-up End Game”. A business plan without an exit strategy is only half complete as it leaves unanswered many important strategic questions about the ultimate fate of your start-up—the “who,” “why,” “when,” and “how” of an eventual exit.
The reality
Let’s start with the reality; you might have no choice.
- Only one-third of small businesses survive beyond 10 years.
- 75% of start-ups that raise more than $1 million do not manage to return the money invested in them
Exit as an option
Most entrepreneurs and their stakeholders are unwilling to sell until they are desperate to sell, waiting until they have exhausted all viable alternatives to a sale, which is pretty much the lowest selling position they can find themselves in. Exit should always be one of the options. Selling your start-up at the right time, to the right strategic buyer, on the best possible terms is what you should consider as one version of success.
Strategy
This means it should be part of your information dashboard, your scenario planning and your strategic thinking. You need to keep an eye out on the acquisition landscape and develop relationships with strategic partners.
It takes time
Acquisitions are not created overnight, so this needs to be cultivated, just like any other network connection. So if you have or want to sell, you have done the groundwork. The author calls it courtship, which is not different from account management with clients.
Do not waste time
While you don’t want to wait too long before you start testing the appetite of potential suitors, you don’t want to engage in these discussions prematurely, either. You should open up acquisition discussions with current or potential strategic partners only when you see a clear path to a reasonably successful outcome.
Long term survival
An acquisition is the most likely path for a start-up’s long-term survival. Think of an exit strategy as a parachute that every entrepreneur who jumps off a cliff to build an aeroplane needs (starting a company is like throwing yourself off the cliff and assembling an aeroplane on the way down). Survival is what gives meaning to the whole endeavour and the pain and suffering that we endure along the entrepreneurial journey.
Be bought, not sold
The trick, then, is to be bought, not sold. Successful acquisitions are typically the result of years of careful planning and deliberate execution. At its most fundamental level, a successful exit only happens if you manage to tie the knot with the right acquirer at the right time and with maximum negotiation leverage. Without a plan, how would you even know who is the right acquirer, when is the right time to sell, and what are the right terms?
Why buy
Common motivations to start a sale process:
- Dilution avoidance
- Obtaining liquidity
- Leverage optimisation
- Mission execution
- Survival
- Market Timing
The exit strategy canvas
The book gives you a canvas:
- Success definition. What would a successful exit look like?
- Core hypotheses. What do you have to believe to be true for a successful exit to happen?
- Strategic opportunities. What are key areas for value creation through partnerships?
- Key acquirers. Who are your potential acquirers, and what are your selection criteria?
- Risks and challenges. What can jeopardise a successful sale to an acquirer?
- Key mitigants. What can you do to improve your chances of a successful sale?
The questions
- How would an exit best manifest the values of your start-up?
- How could an exit best promote the mission of your start-up?
- What would be the ideal time frame for an exit transaction?
- Think of companies in your ecosystem for whom you could fill a strategic need, such as adding revenue, adding profits, staving off a competitive threat, accelerating time to market for a product or service, or improving their market share.
- What are the prioritisation criteria (strategic fit, customer fit, culture fit, financial means, etc.)
Handbook
The book has a tendency to teach grannies to suck eggs, but it also means it is very comprehensive and can be used as a handbook. From brainstorming to networking, selling to account management (reminds me of “The Qualified Sales Leader“), team building, negotiations, communication, etc.
Tips
- Focus on momentum.
- Meaningful business transactions only happen when the parties actually know and like each other.
- An acquisition seldom happens without the parties having had an extensive period of courtship that builds familiarity and trust between them.
- In the overwhelming majority of acquisitions that the author has been involved with on the buyer or seller side, the acquirers have had at least one year of prior familiarity with the target leadership before signing the merger agreement.
- Cultivate champions among your allies.
- Activate your hidden network.
- Create leverage.
- Buyers have the most precious commodity on their side: time.
- Whoever can walk away from a negotiation has the power to dictate its terms.
- Start-ups that have a solid grasp of their customer data and metrics for their products tend to be the ones that rise to the top of the acquirers’ pipeline.
- The more data-driven insight you can provide to support your forecast for both cost synergies and revenue synergies, the more accurately your counterpart will be able to model its acquirer surplus and the less of a discount it will have to apply to its valuation.
- Find the acquirer’s resonant frequency.
- Enhance your appeal (strategic fit, culture, vision).
Common risks of starting a sale process
- Team distraction. Many entrepreneurs misinterpret the signals and intentions of a potential acquirer and end up wasting invaluable time, distracting their team, and ultimately disappointing and demoralising them. Or worse.
- IP and competitive risk allude to opening up your books and allowing the potential suitors a peek under the hood of your proprietary data, technology, and processes comes with a lot of inherent risks. Information you provide them may ultimately be used against you if your sale process falls through and you decide to continue to independently compete in the market. Consider using a clean team.
- Negative publicity in the press and blogosphere.
- Loss of talent due to aggressive poaching/recruiting by others.
- Loss of key partners or customers.
- Lawsuits. Opportunists, such as patent trolls, anticipating you would want to quickly settle rather than deal with a lawsuit in the middle of acquisition discussions,
- Internal misalignment.
The process
The typical company sale process unfolds in five stages: (1) buyer outreach, (2) preliminary diligence, (3) term sheet collection, (4) term sheet negotiation, and (5) deal execution.
Stage 1: Buyer outreach. In auction terminology, this stage is typically referred to as bid solicitation.
Stage 2: Preliminary diligence. Interested acquirers typically start their work by either asking for your teaser presentation or your CIM (short for confidential information memorandum, sometimes also referred to as offering memorandum (OM) or information memorandum (IM) or a pitch deck during venture capital fundraising.
Stage 3: Term sheet collection. The process letters typically require the following information to be submitted by a certain deadline:
- Purchase price
- Methodology and assumptions behind purchase price calculation
- Form of consideration (which is typically cash and/or stock) and its source
- Timing and structure of payment
- Key assumptions, remaining topics and questions for diligence, and nature and extent of diligence
- Timeline to finish diligence, signing, and closing
- Required approvals (internal and external) and other conditions for closing
Stage 4: Term sheet negotiation. “Are we negotiating?” To which the devil swiftly responds, “Always!” And that is the simple truth. Whether or not we mean to, we are always negotiating.
Stage 5: Deal execution. The communication, integration planning announcement and day one. Take particular care of the technology platform and the technical debt that you will accrue. Our experience with AgilePoint is that a merger is a perfect time to move to a codeless architecture and remove the complexity of the business model by abstracting the process at a meta-level, making the new business more efficient, dynamic and adaptable,
The transparency Dilemma
In the preliminary diligence phase, acquirers need to be confident that they understand the major upsides and downsides of buying your start-up. They need to go beyond gut feelings and intuitions and obtain some evidence that the terms and valuation they are proposing reflect the reality and genuine prospects of your start-up. There are trade secrets and other details you may not want to share with an acquirer before a term sheet is signed. That is fine and perfectly understandable by acquirers.
The valuation dilemma
In that case, you may hear about key metrics they consider in their analysis and the multiple ranges they attribute to those metrics (e.g., 2x to 3x multiple on revenue or 10x to 15x multiple on EBITDA). Still, ultimately, the final valuation is determined based on how competitive the bidding process becomes and how much leverage you have. Yellow highlight | Location: 2,986
The testing dilemma
For instance, they may want to run a marketing campaign for their product within your customer acquisition funnel; my guidance in such situations is to delay running such tests to the post–term sheet confirmatory diligence stage.
Technical details
The book then goes into detail, and it is excellent. Topics such as purchase price, enterprise value, hybrid cash, equity transactions, tax implications, earn-outs, escrow, holdback, stock options, equity awards, parachute payments, representations, warranties, survival period, indemnification, governance, required approvals, exclusivity, lockup period, expiration date, deadlines, deal fatigue, signing and closing. The key message is to make sure you fully understand it and uncover the assumptions underlying various terms.
Mortality
Awareness of mortality tends to bring clarity of purpose and urgency to one’s actions. The most common regret of the dying is not having maintained meaningful relationships amidst the busyness of daily life. We need to adopt the same stance toward the future of our start-ups to give them the best chance at success and survival. The key is to create a thoughtful long-term strategy early and maintain our momentum in executing it over the years.
Mitigate risk
The old Persian proverb says, “Whenever you catch the fish, it is fresh.” Getting started today is much better than tomorrow. Being committed to creating a profitable, lasting company is not at odds with having a viable exit strategy. Just as jumping off a cliff without a parachute would be ill-advised, so is toiling away at a start-up without an exit path to mitigate against existential risks and maximise your upside potential.
