Exit Plans for Startups
It might seem strange to consider exiting when you're just starting up and preoccupied with assembling a team and getting funded. But thinking through, planning for and working toward an eventual exit is something every entrepreneur needs to do.
Why is having a startup exit plan important?
Your end goal affects everything from how you run your business, to the partnerships you pursue, to how you choose to fund your startup. By thinking and planning ahead, you're much more likely to be prepared when you do exit--whether that's in 18 months or 10 years down the road.
The nature of being the head of a venture-backed startup is that you have to grow your company quickly, you have to grow it huge, and then you have to get out.
Even though many people might want to keep their company small and private for as long as possible, for investors this is a losing scenario. Investors want to invest their money for a limited amount of time and then get a return on their investment.
About 90% of all companies investors put money into will go bankrupt. This means that investing money in your startup comes with a pretty substantial amount of risk. The only way investing becomes worthwhile to the investors is if the remaining 10% of companies they invest in that survive give them a return of ten, twenty, even fifty times their investments. Every investor has a target goal for their return. And those 10% have to provide a substantial return for the entire fund.
From the perspective of an investor, investing $1 million and then selling for $10 million won't provide the return they're looking for. Don't get me wrong, that's a lot of money and a person can live quite well on the return, but it isn't what VCs are looking for.
That leaves startups with a profound need to grow — and then exit. An exit is the term for when an investor gets a return on their investment in a venture-backed startup.
There are two basic exit strategies all startups follow:
An acquisition is exactly what it sounds like. A larger company, usually one that is well established and has interest in the product the startup has created, will offer a substantial amount of money to purchase the startup. The purchase can be made in cash, stock, or some combination of both. If the startup sells for a good valuation, the investors receive a good return on their investment. If not, they may just receive their money back or possibly just some portion of it.
IPO stands for Initial Public Offering. This refers to the startup turning from a privately owned company into a publicly traded one. In this case, the investors won’t necessarily get out immediately, but they at least now have the option to sell and trade their stocks on the open market. The fact of the matter is, only a few companies are able to reach this point.
In a study done by CB Insights, the data validates the conventional wisdom: nearly 67% of startups stall at some point in the VC process and fail to exit or raise follow-on funding. You can see the report here.
Notice that the exit in these cases aren’t necessarily an exit for the founders of the company.
When we talk about exit plans, we’re talking about a way for the investors to get their money back, but the founders of the company, whether in an acquisition or IPO, may still work with and grow the company.
The point in each case is that investors don’t want to invest in a company that eventually goes bankrupt, and they don’t want to own stock in a private company that leaves them with no opportunity to sell.
No matter how much they love your company, investors want to see a huge return, so it is essential to know your exit plan and aim to get big and get out when you start your company.
Maybe you have your eye on being Google's or Facebook's next acquisition at a rich multiple. So how do you make that happen?
Make sure you aren't a "me too" player. It can be hard to overcome first mover advantage. Focus on filling an unaddressed market need and owning your product niche.
Invest in your team. Many acquisitions are driven as much by the desire to lock up scarce talent as they are by acquirers wanting to get their hands on a killer product. Make sure you recruit A-players who produce tangible value as a team.
Be careful when entering into business partnerships and/or significant contracts. Make sure any partnership or contractual agreements you enter into include options for early termination and/or the ability to assign them to a successor entity.
Keep your capital structure simple. While most exits are through acquisition and not IPO, make sure any investors you take on understand and buy into your strategy and that there are no minority investors in a position to throw a wrench into a deal. Also, avoid including lots of small investors in your capital structure.
As you can see, there's no one right answer. But you should define what success looks like for you. And if you plan to take on outside investors they will expect you to be able to clearly spell out your path to an eventual exit, the milestones you need to hit, over what timeframe, and your anticipated valuation at exit. They'll also expect you to produce data points to back these up.
For help with your Exit Plan, contact me at firstname.lastname@example.org.
Feel free to also visit our website to learn more about the services we offer to help you Position Your Potential: https://www.therevenuegroup.net/.
I also invite you to download the white paper and learn the 5 step process on How to Quickly Increase Your Valuation: a Proven 5 Step Process.