Exit strategies — some pro tips for startups.
Official communication of VCs is packed with investments news. Common practice is that when it comes to investment exits, only successful ones break through to the media, which is understandable, but also has its consequences. The thing is, that exits transaction processes and strategies leading to them, still receive too little attention — also from the founders. Definitely not as much as “preparing a good pitchdeck” or “choosing your optimal business model”.
In fact, it was our recent IPO that made me think. As a VC firm we have the experience with various kinds of divestment transactions. What’s more — we require startup founders to be ready with their exit strategy idea and discuss it during investment talks. Too often — ready they are not, which means that they are not aware of the importance of the issue before fundraising.
Hoping that founders read our Black Pearls VC blog (I heard they do), I decided to share some of my thoughts on the three important exit types and send the message that you really have to think about exit strategies before you enter a VC’s portfolio.
Management buyout (buyback).
Typical for private equity sector transactions, MBO means selling the company to the next generation of managers. Usually it doesn’t happen without the support of debt financing and/or PE investment. There are also other transactions where founders acquire the shares held by the investor (often a VC fund) and take full control (and responsibility) over the company.
According to Invest Europe 2016 data, every fourth exit in CEE was done this way, with only a trade sale being more frequent. Does this mean that it’s the best exit strategy? Of course, it all depends.
MBO — startup perspective.
MBO is for mature companies that want to continue their future as private enterprises. The buyout means that founders (or sometime the future generation of managers) decide to run the business more independently. Obligations like reporting are no longer present, so are the third parties in the companies structures and decision-making. An attractive vision for sure.
But the benefits will come only when the assumption of infallibility of the independent owner’s decisions is right. No third parties mean less points of views, less discussion and 100% responsibility. Our observation is that only the best can handle this.
MBO — Black Pearls VC perspective.
Using an MBO as your exit strategy while you pitch your project or negotiate the terms of investment may be a little bit tricky, as sometimes the statement it involves could discourage potential investors. Most of Black Pearls VC transactions based on the MBO mechanism concerned companies where our involvement fulfilled its role and the company reached the stage of a profitable business. It means that the company’s further development can proceed based on its own resources or debt financing.
Sometimes a company loses focus on dynamic development and turns into a stable business the scale of which is satisfactory to the founder, and not necessarily satisfactory to the fund — in that case MBO could be a sensible option. Of course, the buyout can be manager friendly, for example thanks to distribution of payments in time. In our practice, many cases of MBO are aimed at protecting the capital invested, although this is not the rule. Take our last year’s exit from PHK, where the parting decision was made at an optimal moment for both sides of the transaction.
The role of MBO in the startup’s strategy.
Founders should remember that management buyout as the exit strategy could (but doesn’t have to) mean that the company is focused on the local or national market and does not really plan a dynamic growth in the long term. And the investment strategy of Black Pearls VC assumes supporting internationally scalable projects. It doesn’t mean that MBO plans will mean we won’t invest. But it means we will want to discuss it.
The discrepancy between the investor’s expectations and the founder’s plans in this area should be identified as soon as possible, and even if the exit strategy will be the reason for the decision not to cooperate, it will save unnecessary problems for both parties.
Here, the shares belonging to an investor are passed to a new one. It could be a trade buyer who saw a unique opportunity in a startup’s potential — for example its technology or market share that will support its core business. Founders should keep in mind that strategic investor’s involvement in the company can lead to losing some control and sometimes focusing on the agenda determined by the corporate partner. Moreover, it must be considered that letting a corporate investor into the financing round might lead to losing control package or simply enabling a takeover.
Strategic investor — startup’s perspective
In case of an MBO, an exit transaction is an important step towards the independence of the business. The emergence of a strategic investor is usually a step in the opposite direction. Such an investor assumes further financing, strategic decision-making processes and sets directions of the company’s development. In return, however, it offers the opportunity to grow dynamically by quickly providing additional financing and providing the company with access to the market on which it operates, opens new contacts and supports the further development of the product or service.
The entry of a strategic investor should mean rapid entry of the company to a higher level of development. Like DeepMind’s AlphaGo beating human players at Go two years after Google’s strategic investment and thus gaining access to necessary data and people.
Strategic investor — Black Pearls VC perspective
From the VC point of view the entry of a strategic investor into a portfolio company is an exit path that often provides a high return on investment and a quick transaction, like, in our case — Everytap (link do newsa). In addition, it usually means putting the company in good hands — we are happy to follow the further development of our investments, despite the fact that our role naturally ends.
The role in startup’s development strategy
The prospect of acquiring a strategic investor is for sure valuable for a VC. However, founders should remember that using it just as a keyword is not enough. If a founder anticipates cooperation with a strategic investor after reaching a certain level of development — he should be ready with some strong arguments to prove the probability it will actually happen.
Initial Public Offering
Initial Public Offering is a transaction in which the company decides to finance further development from capital raised on the stock exchange. Under this model, the current investor leaves the company by selling shares on the public market at some point.
IPO — Startup’s perspective
Through the presence on the stock exchange, the company gains access to an unlimited source of capital, real market valuation, additional marketing tools, credibility and prestige. A listed company has easier access to debt financing, is more reliable for contractors, the list of benefits goes on. All these factors favor the development of the company.
Sounds great, right? But the advantages of being on the stock market, however, rarely materialize in the short term. During recession, current company valuation could be very problematic for the issuers of shares. Especially in this period, companies are exposed to hostile takeovers, and banks and bondholders demand greater security. The need to comply with information obligations generates additional costs and allows competition to monitor the company’s actions.
I strongly advise against a short-term approach towards entering the stock market and treating this as something different than getting access to a dispersed source of capital. Presence on the trading floor has a great value only if the issuer knows how to use it skillfully. Well-built free float, and consequently, shares liquidity and fair play towards investors, are the foundations on which you can build the company’s value and enjoy all the benefits of the public market.
With a professionally run IPO process, these benefits can really be at your fingertips. However, poorly organized stock exchange debut can be observed very often. The risks are huge — once lost on the stock exchange, the company’s trust rebuilds for a very long time or even not at all.
IPO — Black Pearls VC perspective
IPO is the most demanding exit strategy. The decision on its selection must be preceded by an in-depth analysis of the company’s situation today and a good plan for its development in the perspective of a few years. The prize, however, can be very valuable — according to EIF (European Investment Fund) data, the average MoC of this type of transaction is the highest among the others.
IPO — The role in startup’s development strategy
Successful IPOs deliver huge benefits for both the investor and the startup. The choice of this road is an ambitious decision and indicates the mature and long-term approach of the founder towards his enterprise. Startups with such ambitions should devote great attention to the choice of an experienced VC to ensure the success of such a complex transaction.
The mutual awareness of the importance of exit strategy should be present at the stage of negotiating the investment conditions. We advise startups to discuss thoroughly their own approach to building the business before holding talks with VCs, especially the horizon in which they want to associate their full and exclusive professional activity with. Founders should also choose investors basing on their divestment policy, exit transactions experiences and preferences. It is extremely important to build awareness of managers about the temporary role of VC in building the value of their company. Both parties should gradually prepare the inevitable exit process to make it comfortable and satisfying for founders as well as investors.