The value of building a business with an exit in mind
It is easier to invest in private companies than it is to unlock value from these investments. While the venture capital (VC) and private equity (PE) investment space is gaining more and more momentum in Africa, the process of exiting these investments remains a challenge.
What many investors and entrepreneurs don’t realise is that positioning a business for a successful exit already starts in the due diligence process — even before investment. Exit strategies will most likely influence the investment term sheet and govern the relationship between the entrepreneur and investor. It is therefore critical to align interests between them.
Exit options for African entrepreneurs
Entrepreneurs could build businesses with the goal of creating future dividend streams or to leave a lasting legacy in a family business, but in many cases growth is enabled by M&A activity and wealth is unlocked through a so-called liquidity event. The most common methods include trade sales (direct acquisitions by other companies), secondary buyouts (PE-to-PE sales), and IPOs (becoming publicly owned and traded on the stock market).
Encouragingly, the latest AVCA study of private equity exits in Africa shows a significant increase in exit activity across the continent. Trade sales to strategic buyers remain the most significant exit route in Africa accounting for over half of all exits, but PE firms were more active than ever in 2014 as buyers of the portfolio companies of other PE firms. Because African Stock Exchanges are relatively illiquid, exits via IPO are rare.
Are we there yet?
In his book: ‘Finish Big’, Bo Burlingham makes the sobering point that all business owners eventually leave or “exit” their roles as Owners/CEOs/Partners. It will happen. Assuming you’ve built a viable company as an entrepreneur you can most likely choose when and how you exit, but you can’t choose whether. Unfortunately, most entrepreneurs do not adequately plan for this eventuality throughout the business building phase while they still have time and options, resulting in value destruction and regret.
Exit-centric business building
Exit-centric business building ensures that growth is engineered so that companies become enticing prospects for stakeholders to do business with — and possibly acquire. It involves generating meaningful traction off a solid foundation of corporate governance and focusing on achieving set milestones.
The investment approach is based on an understanding of the growth gaps in executing an ambitious strategy and overcoming the challenges faced at each stage of the business building cycle from startup to sale. The business should be packaged and enabled to rapidly react to any window of opportunity for corporate activity. Keeping a virtual data room relatively up to date is never wasted energy.
Build to last versus build to flip
Jim Collins summarised the problem with the concept of building companies exclusively for a quick exit in a 2000 Fast Company article — Built to Flip:
“We have arrived at a unique moment in history: the intersection of an unprecedented abundance of capital and an explosion of internet-related business ideas. But, for all of the incredible opportunities unleashed by this combination, there is one monumental problem: the entrepreneurial mind-set has degenerated from one of risk, contribution, and reward to one of wealth entitlement.”
Building a business with exit in mind is not the same thing as backing a flippable business idea where it’s about getting in, getting out, and moving on to the next idea before the bubble bursts. It is more about developing a business model on the idea of creating an enduring, great company — but with a deeper understanding of the end goal. If you do not end up exiting the business, it does not signal disaster since you’ve built a sustainable business for the long run.
Understanding business value drivers
Creating a valuable company includes having a solid business model with recurring increasing revenue streams, a manageable cost base and a strong balance sheet. But in a high-growth venture there are other considerations at play, as value is not created linearly. Significant valuation increases usually occur in discrete steps rather than through smooth linear growth. These stepped increases in value occur when individual strategies — such as establishing strategic partnerships, expanding to new territories and introducing new products or services — are successfully implemented.
Focusing on the different ‘traction verticals’ in your business can advance these inflection points. If you overlay industry lifecycles that fuel M&A activity, the timing of any exit or liquidity event becomes an important value driver. During a consolidation wave, an industry leader built on business fundamentals becomes a hard prospect to ignore for a strategic buyer — especially if no other sources of funding are needed besides self-sustaining growth.
Generating inbound interest
In order to survive due diligence and receive premium valuations, companies must be able to clearly articulate their value proposition, business model, financial profile, total addressable market and its positioning within this. “Premium value can be unlocked if you position your company to be acquired as opposed to selling it”, says Tim Harned from leading Boston-based investment bank and M&A advisor: AGC Partners. You need to generate inbound interest from the right potential partners by creating an enduring, great company that pulls people toward its products and activities, where they intuitively want to be. The partnership opportunities one can then pursue are endless, including joint ventures, M&A activities, follow-on investment and partial- or full exit.
Enabling African entrepreneurs to reach a shared goal
In order to kick-start more early-stage M&A activity in Africa and attract investors to this space, a deeper understanding is required of the virtuous cycle of starting up and exiting. Investors and entrepreneurs who jointly craft their liquidity events will pursue a shared goal. On August 21, Knife Capital and Moneyweb are hosting the second annual Exit Conference at the Money Expo in Sandton, Johannesburg to focus on the process of reaching a successful exit in/from Africa. The speaker profile include M&A experts with experience in exiting African private companies as well as dynamic local entrepreneurs who have built and sold their high-growth ventures.
Remember that good companies are bought and not sold. If you build a sustainable well-managed company by pursuing a scalable business model, interesting opportunities will present themselves every now and then. Be prepared to grab the right ones!
Adapted version of my original VentureBurn Post (May, 2014)
