What every startup founder should know about exits

The dream of a startup founder can often be summarized by the following, well-intentioned, and mostly delusional quote, “We’ll raise a few rounds and in a few years we’ll IPO on Nasdaq.”

But a more likely scenario looks something like this.:

You invest a few years of hard work to build something of value. One day you receive an acquisition offer out of the blue. You’re elated. And you’re not prepared. You drop everything to focus on this opportunity. Exclusive due diligence starts. Your company is a mess (IP, contracts, burn). Days become weeks; weeks become months. You’ve neglected business and fundraising. You’re running out of money. M&A is now your one and only option. The buyer says they found a bunch of cockroaches in the walls and drops the price. Now what?

Sounds unlikely?

This is still a favorable situation: you had an offer! Think about how much time you invested in your various funding rounds. The hundreds of names and Google spreadsheet or Streak-powered quasi-CRM process.

Have you spent even a fraction of that on understanding exit paths? If you’d rather not live the situation described above, read along.

The E-word: A Strange Taboo

Investors live by exits, but many founders keep dreaming of unicornization and avoid the “E-word” until it’s too late. Yet, in 2016, 97% of exits were M&As. And most happened before series B.

Exits matter because that’s when you, your team and your investors get paid. Oddly enough, and to use a chess metaphor, we hear a lot about the “opening game” (lean startup), the “mid-game” (growth) but very little about this “end game”.

As a result, founders miss opportunities or leave money on the table. This is a shame. Our fund, SOSV, has over 700 companies in portfolio. We want the best possible exit for each of them. And fortune favors the prepared! Now, how to get 700 exits (and counting)?

To explore the topic, organized a series of Masterclasses tapping corporate buyers, bankers, investors, lawyers, and startup CEOs with M&A or IPO experience in San Francisco. It was a group that included the founders of Guitar Hero — bought by Activision; JUMP Bikes — a SOSV portfolio company bought by Uber, Ubiquisys  — bought by Cisco, and Withings — bought by Nokia. Each one for hundreds of millions).

Their observations can be summarized below.

Maximize Optionality

“Founders must be aware of what contributes to an exit. This means understanding partnerships and how they are formed in the business space the entrepreneur is working in,” said one MasterClass participant.  

As founders, you build your product, your company and… optionality. You need to understand the options open to your company, and take steps to enable them.

The most likely one is an acquisition but there are others like IPO (including small cap), RTO, SBO, LBO, Equity Crowdfunding and even ICO.

“Exit is not a goal ​per se, but as a CEO it is something you should think about as early in your cycle as possible, while being business-focused,” said the London-based investor Frederic Rombaut, of Seraphim Capital.

Indeed, most participants said that exits should always be on the chief executive’s agenda, no matter how early in the process. “Exits should be on the CEO agenda. Not front and center, but on the agenda. M&A is a by-product of a great business and targeted BD. IPOs are always an option once you’ve built significant cashflow forecasting.”

It’s important to ask questions like: How many “strategic engagements” with potential buyers have you had this month? Is your message and value clear in their eyes? Have you considered an acquisition track in parallel to a fundraise?

It doesn’t stop there:

• Equity crowdfunding might help close some gaps at seed stage.
• Early IPOs on smaller exchanges can be an option to raise over $10M — the robotics startup Balyo went public and raised 40MEUR on Euronext to get rid of a critical ‘right of first refusal’ option held by one of its corporate investors.
• Reverse mergers can work too: the medical exoskeleton company EKSO Bionics went public this way.

One thing is sure: the time to exit is not when you’re running out of money.

Companies are bought, not sold

Unicorn or not, the most likely exit is an acquisition.

As George Patterson, Managing Director at HSBC in New York said, “Good tech companies are bought, not sold. The question is thus: how to get bought?”