Welcome to Spencer Trask Perspectives, a monthly interview series with our CEO Bill Clifford and writer John Essick. In each installment, Mr. Clifford shares his unique insights and expert opinions on topics such as business development, deal flow, C-suite management, startup culture, entrepreneurialism, and more.
We welcome your feedback, and encourage you to submit questions to askST@spencertraskco.com for Mr. Clifford to answer in future articles.
Since February of 2020, COVID-19 has been disrupting sectors and industries across the board. As of November 1st, 556 corporations have filed for bankruptcy, according to S&P Global Market Intelligence. We have watched Wall Street suffer, as much as Main Street. While most of the attention has focused on businesses working to recover and get back to some resemblance of ‘normal,’ often overlooked is the effect the pandemic has had on entrepreneurs and small business owners who were poised to sell their business when the pandemic struck or even had plans to sell within the next two or three years. Buyers they had hoped to attract have pulled back, and it is unclear when they may reappear or what metrics they will use to judge a company’s worth. In addition, it may be several years before entrepreneurs and small business owners see pre-COVID valuations for their companies.
I spoke with Spencer Trask & Co. CEO, Bill Clifford for his thoughts on how COVID is affecting the future of exit strategies of entrepreneurs and small business owners, and what steps they may take today to prepare for when buyers reappear.
John Essick: How many months or years do you think COVID has set most business exit strategies back for owners?
Bill Clifford: Not to hedge my answer or avoid giving you my honest opinion, John, but this is a clear case where I have to say it depends on the company and on the market segment they were participating in. For companies that were dabbling on the fringes of the healthcare industry or were component suppliers to PPE manufacturers, ventilator manufacturers, digital thermometer makers, software suppliers and telephone technology suppliers to telehealth companies, etc. saw their windows to exit compress sharply during this period, as their revenues and earnings were boosted by the overall surge in purchasing in response to the pandemic. These companies became prime targets for acquisition by larger industry players looking to roll up a given market segment to control price and supply while building brand image.
While the world was focused on COVID-19 and all its repercussions, other more mundane companies with exit aspirations found themselves in a bit of a dilemma. If they had reached the point in their exit planning where they had developed a short list of exit strategies (i.e. public offering or strategic sale) then they were likely faced with the choice of retracting their “S” level filing and having their investment bankers try to keep prospective investor warm for an offering down the road when the pandemic has passed (provided of course that the company survived the pandemic without disastrous financial implications!), or keeping their potential strategic partners warm and interested during this same period. The alternative to both scenarios is to lower the exit price (i.e. lower the per share offering price or lower the sale price to the strategic partner). In essence, conducting a fire sale in the teeth of the pandemic. This would be a strong signal to public investors and to the strategic buyer that management has little confidence in its ability to manage through the pandemic and the likelihood is that the price would literally “fall like a rock.”
JE: How can business owners alter their current exit strategy in a post-COVID-19 world? What data should they be tracking now to prepare for a sale or M&A down the road?
BC: I have seen some very creative financial presentations by companies that had been forced by the market to offer contract terms and conditions that were different from their traditional T&Cs. For example, instead of an outright purchase of their products, customers were insisting that the company lease their products over a 3,4, or 5-year period. This, of course, played havoc with their cash flow in the short term and occurred right at the time that the company became an acquisition target. To overcome this issue, the company created two sets of financial statements: one was the GAAP compliant set, and the second set reported results along the lines of the company’s historically reported revenues — that is when customers purchased, not leased, their products. This set of financial statements was referred to “as if sold” and gave everyone who reviewed the results a common benchmark against which to review the current periods against prior year results. This was most helpful in assessing the health of the company and resulted in a successful financing.
It is these kinds of creative techniques that companies need to think about today to make their sale or M&A event successful tomorrow. If they had a strong and successful track record pre-COVID-19, and the pandemic has taken them off the track but their fundamental strengths are still demonstrable in their financial results, they must do all they can do to highlight these strength, including keeping a separate, second set of financial statements which reflect these more positive results. Or, stating the financials in a way that more accurately reflects how events would have transpired, without the impact of COVID-19.
JE: What information would prospective buyers and investors look for in a post-COVID-19 world?
BC: Today’s buyer and investor are looking for the same things they always look for, plus a few extra attributes that most of the survivors of the pandemic should proudly demonstrate. To have survived the initial wave of business failures of the spring and early summer is a testament to any company’s flexibility and resilience. It is doubtful that a company of any scale could survive the pandemic without a strong leader and a strong bond between that leader and the management team. These are two key attributes that investors and strategic buyers alike look for in a company prior to making an investment of any kind. The company’s survival also speaks to the attractiveness of the product line, since the pandemic had the effect of forcing markets to focus on must-haves not nice-to-haves, so optional, discretionary and frivolous products did not survive long in that cut throat environment. All these attributes combined result in a company that would be an attractive investment/acquisition target post-COVID-19 for the right buyer.
JE: What is the general mindset and landscape of VC right now?
BC: The Venture Capital community remains hungry for opportunities for the right deals at the right prices, and investment capital is available. Some firms actually started funds focused on companies that dealt with COVID-19 related products and services in the healthcare sector. That particular sector has exploded along with telehealth and anything related to home health improvement, home gyms, etc. At home fitness apps, for example, were up by 64%, year over year, as of October 18th. In that same timeframe, videoconferencing apps were up by 328%! These sectors are not expected to compress back to pre-COVID levels after the pandemic has passed — in fact they are forecasted to continue to grow steadily as we have become accustomed to working from home, exercising at home, and getting our healthcare delivered to us through telehealth media.
JE: The past 9 months have no doubt caused many business owners who had planned on selling their business over the next few years to put those plans on hold, while others who may have been on the fence have determined that it may be time to develop exit strategies. Would you suggest these owners get out as soon as possible, or would it be better to focus on and strengthen key metrics and wait until things improve, even if that means waiting for several years?
BC: As I said above, if you as the entrepreneur can present metrics and results that show your company in a positive light, despite having some difficult periods during COVID-19, then trust that your prospective buyers will understand and see that your company has performed admirably during a difficult period. If you are simply getting out “as soon as possible” before things get worse, then also trust that your prospective buyers will also see through that scenario and likely build in purchase protections, like earn out clauses, etc. so that they are not left holding the bag while you skip town with their money! If you really have a solid business that can perform and yield positive results, then your best return would result from holding on for a few more years and posting some more solid results before selling.
JE: Do you think that the disruptions and uncertainty that COVID created for so many businesses, particularly startups, will create a surge in entrepreneurs looking to sell off their companies and pursue less risk adverse futures, or is the drive to create regardless of risk just something in an entrepreneur’s makeup?
BC: The desire to start and build a company is something that flows within the veins of the entrepreneurs body, and I suspect will not be dampened by the disruptions and uncertainties of a pandemic like COVID-19, or any other phenomenon. True entrepreneurs are focused and driven — almost maniacally so — on their goals, and view events like COVID as temporary obstacles on the way to success. They may hibernate for a while waiting for the storms to pass but I doubt that you will see the true entrepreneur deflected from their true mission for long!
JE: It takes much stamina, hard work, and perseverance to make a company successful and that is even more true today with the disruptions and uncertainties many businesses face. It seems counterintuitive to be considering exit strategies at the same time. Is an exit strategy something that should be in a startup business plan from the start, or is it something to consider once the company is successful?
BC: That is an interesting question, and again, I will have to say that it depends. In this case, it depends on who is financing the company. If the initial capital is coming from the founder or the founder’s friends and family, then the path to the exit is often poorly defined and very ‘loosey goosey’ — meaning it is totally under the control of the founder who may or may not ever want to exit if they are having too much fun!
If the seed capital is coming from a more institutional source (i.e. a Venture Capital firm, a bank, etc.) then you can expect that a more formal business plan was created with financial projections, cash flow projections, a Board of Directors or Advisors, and a plan to return the invested capital with a profit. In this case, the exit plan is clearly defined and, while it might not be executed exactly as described in the business plan (it rarely is), at least everyone understands that the company exists to make money for its shareholders and investors through some kind of monetization exit.
JE: Key personnel time is a valuable resource for many small companies and getting things in order and responding to a buyer’s due diligence requirements can eat into the time that might be better spent keeping the business afloat. How does leadership determine if preparing for a sale is worth it right now? Should they consider bringing in outside consultants?
BC: I have always found that well-run companies did not really have to distract their key management team members, nor did they have to create financial reports, schedules, or analyses as part of due diligence that they had not already prepared many times before as part of their own internal management reporting systems. The information that buyers are looking for is the same kind of information that senior management would use to evaluate the performance of their own company — particularly as it relates to competitive analysis and financial benchmarks — so requests from prospective buyers would likely follow much the same kinds of thinking, namely how does the company’s products stand versus the competition and how does the company’s financials look versus industry norms.
JE: When assessing an exit strategy for a company today, do you think the numbers or metrics that made businesses attractive to suitors pre-COVID will matter, or will suitors take new equations into consideration post-COVID?
BC: What made a deal attractive pre-COVID will make it attractive post-COVID, and vice-versa. If you were an ugly duckling but survived through the COVID period, then kudos to you for your creativity and perseverance — it might be enough to earn you a second look from buyers or Venture investors. However, if your fundamentals are not any prettier than they were pre-COVID then your chances of finding a suitor are not likely to improve. The end of the pandemic does not mean that all the rules of the investment game have changed. The fundamentals remain the same — strong and predictable revenue growth, expanding margins, expanding markets, cost control, competitive advantage, etc. If you bring these to the table, either pre or post COVID, you will have an audience of suitors.
 “Measuring the Reopening of America: The GS US Reopening Scale: Range of recovery paths widen for different categories, remain a ‘4’ (Week of Oct 21).” October 21. 2020. Goldman Sachs Equity Research.
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About Bill Clifford
Bill Clifford is Chief Executive Officer of Spencer Trask & Co., a privately owned advanced technology incubation firm. Prior to joining Spencer Trask & Co., Mr. Clifford served as Chairman of the Board and Chief Executive Officer at Aperture Technologies Inc., General Partner of The Fields Group, and General Partner of New Vista Capital. He is also the former President and Chief Executive Officer of Gartner Group, the world’s leading authority on the information technology industry, user and vendor technology strategies and market research. During his tenure at Gartner, annual revenues increased from $175 million in fiscal 1993 to $780 million in fiscal 1999.
Mr. Clifford currently serves on the board of directors of Cybersettle, Inc. He has been featured in CEO Magazine, Leaders Magazine and Forbes, and is a keynote speaker and panelist at numerous Technology Industry conferences.