Exit Early and Often: A New Age of Limited Options for Entrepreneurs
I rarely meet an entrepreneur (or one of their investors) who doesn’t believe their venture will be a runaway hit. In three to five years, I hear over and over, we’ll be able to go public or sell big, providing huge returns for those who got into the deal early.
Many won’t reach that mark. Some will fail by way of a poor product or mismanagement. Some fall to competition, and some to bad timing or bad luck. And there will always be a few entrepreneurs who will get a chance to sell their business for a sizeable return—but turn it down believing there are greener pastures ahead.
There was a time when this made sense. If the company had good traction and was rapidly gaining attention, waiting a couple more years for a big payout was absolutely the right thing to do. No more, though; the new age of exits has more limited options. For starters, the IPO market is a fraction of what it used to be.
The regulatory requirements of Sarbanes-Oxley, along with higher fees charged by NASDAQ and other exchanges, have made it harder for companies to go public. It’s mainly for this reason that IPOs make up only about 10 percent of exits today, versus 90 percent 20 years ago.
The consolidation of VC funds also has created fewer deals, particularly for follow-on funding rounds, so the opportunity to grow a company on a very large scale can be limited. For example, the funding model used by the Tech Coast Angels (TCA) prior to 2008 included investing alongside VCs in one or more venture capital rounds. Today, only 13 percent of follow-on funding comes from VC firms.
That leaves acquisitions by a larger firm as the likely exit option for a startup. Big companies typically seek to acquire companies generating annual revenue between $10 million and $30 million, with a price tag under $100 million. Anything above that is typically outside an acquirer’s “sweet spot.” In fact, most private company M&A transactions are under $20 million.
So entrepreneurs and their investors should adjust their exit strategies to match the realities of today. The “10X” multiple goal over five to seven years, while commendable, is far less likely these days. That doesn’t mean a startup can’t have a successful liquidation for its founders and partners, however.
By formulating a “5X” return strategy within three to five years, startups can still provide value to shareholders. Doing so does several things. First, it allows investment groups like the TCA to show a greater positive return for its members than what has transpired over the past decade, thereby energizing TCA funding sources to invest more and seek out new deals. Additionally, entrepreneurs with a quick success under their belts will have the capital to launch another venture, putting more innovation in the marketplace at a quicker pace.
Some of the best deals come with multiple exit opportunities. If a company has identified a variety of different points where an exit is possible, they put themselves in an enviable position. One thing we know for sure is that the environment and the startup will evolve over time, and they will never be in the exact position they thought they would be at any exit point. As those inflection points evolve, the founders and investors can evaluate each exit opportunity or continue to raise the capital needed to reach the next step. Entrepreneurs with these kinds of analytical, market, and operational insights are better able to optimize an early exit.
To use a baseball analogy, while we all want to swing for the fences every time, the best option is usually to get a series of base hits that scores runs more consistently. If garnering numerous successful exits is the goal, then we should look at ways to leverage the existing funding vehicles to get more frequent returns. An early, but still sizeable, strategy might very well be the proper course of action.