Early Exits are a Natural Consequence of the Internet

I think you misinterpret the comments. The argument is not that early exits are bad for the entrepreneur, it's that they're counter to the development of a vibrant, sustainable Vancouver tech scene.

The route you're proposing would have entrepreneurs view selling early as the ultimate goal, rather than building something sustainable with huge growth potential. In essence, what you appear to be proposing is that instead of building something truly new, entrepreneurs should carve out a niche in something that's modestly innovative and dump it quickly to someone else who can really leverage it to make the real money, or kill it because it's a competitive product.

It's aiming for third. It's typical BC small-time attitude, and it grates on me since I've moved back from Silicon Valley. It's got to stop.

I'm not saying that means turning down an early exit blindly - merely asking the entrepreneur and angel communities in Vancouver to set their sights a little higher.

I'm sick of seeing the same handful of big local companies get patted on the back again and again. We need to be expanding our tech scene by building big new companies. That requires a vision for the long term, not flipping to make a quick buck.

The long term benefits of early exits depend on the individual case. Obviously, the sellers (VC's, and other owners) usually benefit from an early exit with a quick high annualized return, but the longterm benefit to the economy depends on the stage of the new venture and the ability of the purchaser(s).

If the venture has progress rapidly through the early growth stage, there is long term benefit to the venture and the economy from bringing in 'long term capital' and ownership with different capabilities and vision from the early investors. Such a transition is indeed a win-win for all involved.

The worst case scenario is where early investors simply "pump" the venture to give it the appearance of success and then unload it to unwary follow-on investors. This type of performance was the primary feeding ground of the old Vancouver Stock Exchange.

There are definite points in the cycle, such as the Internet bust, when any exit can look pretty attractive. Similarly, there is long-held benefit of 'a bird in the hand'. But, I have to agree with Brendon.

There is more than just the appearance locally of a quick-buck or chip-shot mentality. Whether this is based upon Vancouver's heritage as a junior mining centre is an interesting debate.

If you are an individual investor, and can make a few bucks, then how not to argue against an early exit? And, taking Basil's Internet analogy a step further, we should not be surprised to see Day Trading culture have some impact on venture investing. Besides, taking a quick exit may be a self-fulfilling prophecy -- sure glad I got out when I did, look at it now.

But, just as many of us can likely point to those that we held too long, many others can point to those we sold too early.

I would also argue with humanity's reluctance to change. Certainly Barrack Obama is hingin his campaign on a desire for change. Yes, there is inertia, but as a species we are very willing to experiment. This is the very nature of the venture opportunities; new ideas, new makets, new technologies, new business ideas.

Even so, there are some pretty established cycles that most new businesses go through. You can decide to exit before the heavy lifting of building a market, and forcing a venture to sell off. But, in so doing, you limit your own future investment opportunities.

If, you are trying to build a venture financing portfolio and ongoing involvement, then even as an angel, then you need to grow your current investments to well past flowering and into seeding the next crop. You need to sprout a forest of future investment opportunities, maybe with a little selection. Seasoned venture players could do well to leverage an agriculture analogy to build bigger and better crops in the future.

Moreover, the research behind Blueprint to a Billion has shown that once a company gets the right pieces in place, there may well be on an unshakeable trajectory to a Billion dollar company. The real trick for investors should be to understand these elements and either assess their presence or help provide them. Who would want to sell a company that can reproducibly double sales year after year for at least three to five years?

The excitement around "Early exits" seems like confusion about cause and effect.

This "built to flip" mentality was proven initially very successful in the dot-com explosion, but it seemed to be more like the cresting of the wave. Once large corps began to jump on the technological shifts, they over spent, and start-ups were awesomely successful. At first.

The business models were being engineered to flip. Nobody was crazy, but everyone were modelling their plans on inflated metrics, and expectations. We all thought an ecosystem of larger companies would eat us up, make billions on ads, or IPO. What seemed like sound business models, collapsed, and worse, cascaded.

Now in 2008, we're seeing the same pattern. A healthy technology shift, powered by social networks, and mobile LBS technologies. Plenty of big investors are elated about this stuff, which is fuelling hundreds of start-ups entrepreneurs to build cool facebook apps or mobile LBS services. But, very few start-ups are actually planning a strong value chain to the dollar, and too many are relying on getting bought by Google.

I personally hate the "Early Exit" from an innovator's stand-point. The whole concept is revolting. It's not respecting my passion to realize a bigger picture. Building to flip, is building another twitter.

If investors really wanted to reduce their risks, it's time we talk about smaller multiples, with sound opportunity to build bigger. Embrace the creative mind, and lets make sure we've got the foundation to scale up big and keep the visionary on-board.

Have a look at this great video of David Heinemeier Hansson (author of Ruby on Rails) at Startup School '08 about addressing the Fortune 5,000,000 and creating a profitable start-up. He nails a lot of delusions on both the investors and entrepreneur perspectives. (Jump to 17:20)

I run a venture capital database, based in Silicon Valley, so I'm a bit of an outsider. But here's my take on the subject.

There are both positives and negatives to early exits. Some of the negatives have already been mentioned. One of the positives that I see here in the Valley is that entrepreneurs who have a successful exit of any kind typically go on to invest some of their windfall (and mentoring) in other very early-stage opportunities. In other words, there's no greater friend to an aspiring entrepreneur than another entrepreneur who is already successful. So exits of any stage tend to serve the local community - by providing a successful model or by the fruits of its monetary gain.

Where would Flickr be now if the Yahoo acquisition had not occurred? What about Octiga Bay today if outside of Cray?

Needless to say it is difficult to categorize early exits.

I am definitely in agreement with the old expression "a bird in hand....." but Brendan makes a valid point when looking at the big picture. It is a common perception that BC companies go early and often for less....So who wants to try to take this thread one step further. If the hypothesis that early exits in BC are a result of low expectations or small thinking then how do we shift our thinking and ultimately our expectations and the results they drive?

The early exit view is somewhat of a reflection of our instant gratification society.

We have all been programmed to expect things faster, in part because of the Internet but also because of Angel groups or VC's who want 10X returns AND the early exit.

Whatever happened to the builders?; entrepreneurs whose goal it was to start an enterprise that outlasts the founders and the early investors?

It is because of this "flip" mentality that it is becoming more difficult to find investors, partners and employees who wish to be part of building a successfull company over the long-term. Investors hear of the spectacular, seemingly overnight success of a company like Club Penguin or Flickr, which of course is a rarity, and from that point forward, managing Board and shareholder expectations becomes managements' biggest challenge.

I am a big believer in building value for the long-term and there are many companies out there, such as ours, that are trying to do just that. It is time to shift the focus from the sensational to the sustainable.

An early exit is a good thing if a few key conditions have been met. One should not instinctively conclude that by an early exit, angel or venture investors are deserting a company.

One is company sustainability. As Phil Gardner stated, the pump and dump model is clearly not sustainable, nor acceptable. However, as soon as a company and its early investors can see that the funding (and guidance) from those investors is no longer required for continued company success, an exit should be welcome. Ideally, that timing will coincide with a healthy return to investors.

Perhaps implicit in the first, is a second criteria - management stability. To the extent that early investors influence the shape and composition of the management team, those same investors should be able to see when they can turn over the reigns to new investors.

A third factor is the importance of preserving a healthy attitude towards angel and venture investing and those investors. Trying to hang in beyond the point where there is a clear need is too easily regarded as opportunism, and undermines the willingness of other company owners to seek similar capital.

Timing is everything. Under the right circumstances, an early exit can be the exactly correct action. Further, whenever angel and venture investors can exit profitably, it usually indicates that other shareholders have also done well and share in the success. To generalize that early exits are all either bad or good, is unproductive.

It's all about timing. From an investor's perspective, I always remember the quote from a successful investor who said, "I've always made money by selling too soon". For those who think early exits are "bad", I'd like to know what's good about a "late" exit and how one makes money with that before it is too late! And, if both too early and too late are not good, just what timing is right? While building stronger and bigger companies in BC is a commendable objective, I concur with Basil that early gains are good for bootstrapping new ventures. And, we all need more winners!

The real decision for an early investor to make when they decide to invest, or exit, from their venture is this: is there any additional value to contribute to the company that my continued participation can affect. If the answer is yes then staying in is the best course of action, however if you are merely looking at status quo, due to exhausted ideas or insufficient capital, then getting out is the best course of action.

I am working on an idea right now that I know is in the "built-to-flip" category. The reason is simple: I have a really great idea, but I do not have the millions of dollars in capital that I know is required to make it really take off. So I can only develop it to a point, hopefully attract a buyer, and take out the value that I put in. As an unknown entrepreneur this kind of investing strategy is pretty much the only way to introduce your good ideas to the marketplace.

Large companies are generally not a hot-bed of innovation. Innovation is expensive, time-consuming, and generally does not have a guaranteed ROI. Any such negative items on the balance sheet tend to chase away investors. Entrepreneurs take risks, they invest in new ideas and they drive change. So from the stand-point of driving innovation this investment strategy is also a "good thing" since it is the incentive to undertake, what is likely to be, an extremely frustrating and scary time for the entrepreneur.

Also, if you stay in past your point of highest contribution you run the risk of losing all of the potential value you have worked so hard for. As with any investment, take your profit when such is presented, because you may only get one chance.

There are no losers here.

Whether we build a company for sustainable means or companies that are "built to flip". We all win. This posts is attracting a lot of negative comments because we wish for something better. Perhaps a little jealous from our neighbours down south. I say there are no losers because they are both profitable. But what we should really be asking ourselves is whether we are content of this result.

Do we want BC or Alberta having this headline attached to their province "We are really good at early exits in BC and Alberta" .If we are then we should continue what we are doing -- because we seem to be doing a great job!

I'm approaching this topic in a broader perspective. Since I'm not originally from Vancouver, when asked, "What makes Vancouver/BC special?" I often find myself scrambling for words to describe this city. Answer to a simple question, isn't obvious.

Maybe, a little too subjectively to prove a point, however describing Vancouver and what makes it special should be second nature to us. Answering this should be as easy as reciting the english alphabets. But if I ask you all what, "What makes Silicon Valley special". You'd agree that most people there are full of optimism, full of dreamers and ready to build something great. Is BC ready for this or we're content where we are? Produce startups and continue selling out?

"The most successful entrepreneurs, directors and investors will find ever better ways to design and execute early exits."

Actually, the most successful entrepreneurs, directors and investors will know when to mash the pedal, or when to start thinking about exits. Whether that happens early or not is beside the point.

What is on point, however, is that our local pool of talent and ambition gets diluted when success is measured by the kind of car your exit lets you buy, not the kind of plane.

Brendan is on point with the first comment.

I used to always think in terms of "early exist" strategy in the flip model in trying to turn an initial angle investment into a quick and lucrative profit. While there are opportunities out there to still be involved in this model, how may times have we really taken a pause and asked ourselves the questions. "are we truly involved in an innovaton, is my investment revolutionizing an industry?

If we are able to answer thisi question, than we will know if we are investing for the purpose of an early exit or in innovation and revolution which will provide a greater future return be it a few years or many years down the road. Having said that, we all know that as investors we have a very short time frame in not only recouping the investment but exiting with a healthy profit in which case there is nothin worng with an early exit strategy.

I believe that this boils down to two points of view - the big picture, and the smaller one. The smaller view is generally held by the founders, investors, option holders of a particular company. For these parties, no gain can be too large, or come too soon. The big picture view concerns the tech industry in BC. And yes, it would be nice to grow more "anchor companies". I think that both views (sell early if the deal is right - hang in, fend off suitors, and build) are valid, but somewhat incompatible.

Maybe some founders find building companies easy (I'm struggling to think of one or two) but for most of us it is a real high-wire act. Fulfilling and exciting for a while, but eventually exhausting. I sold twice within five years and have never regretted it. Both products are still here in far more significant companies, one locally owned, the other foreign-owned. I really doubt that i and my co-founders could have taken them this far.

To conclude, whether early exits are good or bad depends on whose view is being expressed.

Yes, I agree with your views on early exiting high risk young investments. Or, rather, I think it might be more appropriate to say that I appreciate an early opportunity for a liquidity event, if so desired. Too often capital is tied up for many years, much much longer than had originally been anticipated.

Your approach is most conducive to continued participation in a difficult area of the marketplace. d

Good post Basil.

IMHO we are good at early exits because we lack the management depth and the volume of money needed to grow big companies today.

Many of our "early" companies can look good coming out of the gate, with a hi "threat" factor. Left over time many of the same companies will disappoint their marketplace, and lose value, so an early exit is the best for local early investors.

The core needs here are seasoned executives who understand sales today and value/trust marketers, and have access to the really deep pockets down South. Too many local CEOs either consider themselves marketing geniuses, when the truth is far far away, or worse, they know naught about it and are unwilling to spend the time to really learn about real marketing.

But this is just one man's opinion.

Reg

I don’t see this as a question you can answer definitively in a generic way. It may be a chicken and the egg – if you have a community with relatively small funders with relatively small portfolios and limited ability to grow large companies (i.e. Vancouver ) – you by definition will get more early exits, and will get relatively good ROI (most teams will pay significant $$ for a first round draft pick, but only a small percentage of those picks will actually go on to score a lot of goals and play a lot of games – in the early stages of development – it is still hard to tell the long term winners). However, if you want to produce LARGE returns, sustainable IPOable companies – then obviously early exit is the wrong approach.

Gle

A couple of thoughts:

1. Early exits are great if the company planned for it in the way it was financed.

2. Be careful not to confuse selling out too early with an early exit. There is a difference. An early exit usually has to do with market events that are out of a company’s control.

When markets consolidate entrepreneurs have to pay attention or they will miss the party. It if very rare when a tech entrepreneur dictates the timing of their exit.

The arguments I read against "early exits" were pretty weak. I am with you on the answer, an early exit boosts returns and everyone wins. And it is in itself a sign of success -- as long as we are defining success consistently.

I thought it was a good article. It raises for discussion a topic not often discussed, as you found in your google search referenced below.

The only downside I could think of from an early exit would be if that exit is an IPO that comes too early and ends up weighing down a nascent company with too many additional public company costs and distractions.

It's just one man's opinion, but here goes.

I used to be negative about early exits because I believed it demonstated opportunism run amok and a lack of commitment. I believed the pleasure was in the journey and being able to look back over a lifetime of building a business and taking a real sense of pride and accomplishment in that.

Now that I have more investments under my belt, some of which have done well and some of which have not, I have a better appreciation for how fickle fate is. Even great ideas and promising business models get crushed by poor timing or changing markets.

An early exit reduces the risk of poor timing or changing markets. Your VC friends are happy to take their money off the table and move to the next deal. And now, older and wiser, I am also eager to take my money off the table and move to the next deal.

Good topic.

I'm 100% for early exits if possible, why, because I was part of deals that waited for a better offer, after we had built more value! In one case the loss was billions, in a recent one we turned down $6mm a year ago and are grumbling about the $2mm we are basically forced to take today.

But value often depends more on the market than intrinsic value, and you may also prove a lower intrinsic value is appropriate, or run out of investors, etc etc.

As long as the offer is good to all investors-everyone makes money, do the deal. I think we get caught up in the desire to build enterprises, create local head office/high paying jobs, be patriotic etc, which are not economic factors, and often destroy value in pursuit of long shot opportunities.

Maybe it comes down to most things-expectations. If the idea seemed to be a platform, many folks saw it in the early stages as the next Microsoft, if those expectations were not reset often enough as reality sets in, then there is disappointment from unmet expectations.

I often say there is no right time, it's either too early or too late, meaning the right time is somewhere in the too early space.

I enjoy your work.

Here’s a little food for thought. How often do the founders get replaced by managers? Isn’t it the rule of thumb that some people are better builders while others are better sustainers? If entrepreneurs are better at launching ventures, then early exit let them do exactly that. Let them cash out and use their talent where it creates the most value: building new ventures. Sure, they may never learn to become managers, and their investors may continue to have high risk profiles, but there is obviously room in this world for their kind. To read more about the difference between entrepreneurs and managers, check out Chapter 2 of Swedberg’s (2000) “Entrepreneurship – The Social Science View” which is a reprint of entrepreneurship icon, Schumpeter’s “Entrepreneurship as Innovation.”

Everyone looks at the desirability of building more RIM’s (for example) but it is like my father’s favorite adage that it is better to be young, healthy and rich than old, sick and poor. In this case better to have large, vibrant and thriving businesses than small, stagnant and failing ones; in my opinion any two of the ideal three is still a good thing. An early exit is much better than an early death or stagnation.

Through the work I do with Flintbox we know that approximately one tenth of one percent of technologies disclosed to tech transfer offices with commercialization potential generate any significant return. So while the discussion about early exit is interesting what is more relevant to me is how much economic value is being created and what path is best for the growth and development of the technology.

Here are two reasons why I believe that early exits cost investors like me money ......

1. The required returns for purchasers of investments which are beyond the angel phase are rising. This means that good businesses that are performing well are being bought at returns of 20%+. At the same time, new assets in the angel phase are getting harder to find and have become increasingly expensive to buy. The balance has recently shifted back from entrepreneurs to the owners of capital but it is not easy to find assets that will perform well to replace assets that will be sold. As an aside, I have been pretty dormant for the last 12 months but have done 3 deals in the last 3 months as reality (from my perspective at least) has begun to return to pricing.

2. Part of the problem is purely from the way that my portfolio is constructed :

- 5% Cash - E(r) = 4%

- 40% Bonds - E(r) = 6%

- 30% Public Equity - E(r) = 10%

- 10% Private Equity - E(r) = 12%

- 10% Property - E(r) = 12%

- 5% Alternative Assets - E(r) = 12%

I account for all illiquid assets on a lower of cost or market basis until they turn into cash. I account for all liquid assets at market. I rebalance the portfolio whenever any asset class strays by more than 5% from my chosen allocation or whenever there is a cash event in an illiquid asset. By definition, my asset allocation rules cause me to reduce the number of units of private equity that I have when there are realized returns. Realizing them sooner rather than later means lower portfolio returns following my rules. As my portfolio is constructed using the classic efficient frontier approach popular in modern portfolio theory, I would not be surprised if other investors who recognise early stage private equity as a valid asset class within a formally constructed portfolio follow similar rules to mine and feel that early exits cost them money.

The end result is that there is conflict between the needs of professional investors who take a portfolio approach with conservative valuations of illiquid assets and serial entrepreneurs, option holders, traders, speculators, stock promoters etc.

I am always skeptical of "one size fits all" solutions and even more so with the premise that early exits are a good thing as It may reflect the conservatism of the regional investment community that makes it a self fulfilling prophesy..

Early exits often make most sense in products that support existing initiatives. If a product is developed that improves or complements an industry standard software program, there is a reasonable chance that it will be acquired by the software company on which it is based for reasons of synergy. Alternately it makes it easier to create a buzz for an IPO. A region with early exits could merely reflect a region that is focused on this strategy.

While I applaud the successes that BC has had in early exits I would not want Angels and support agencies to inadvertently discourage the more bleeding edge initiatives. Finding a cure for cancer or trying to turn trees killed by pine needles into fuel may not be for the faint of heart or for those that desire an early exit but BC has a history of innovation and a deep pool of talent and I hope that a small part of it will continue to shoot the moon.

Hi Anthony,

I find it hard to believe that "new assets in the angel phase are getting harder to find and have become increasingly expensive to buy." I couldn't find you in LinkedIn, or Google, so I don't know which geography you're in. I will only speak for Vancouver, in which case I suggest a few avenues to rub shoulders with budding entrepreneurs:

- www.newventuresbc.com

- www.angelforum.org

- www.vef.org

- www.bctia.org

- www.newmediabc.com

- www.launchpartyhq.com

- blog.bootuplabs.com

- www.montejade.org/?page=message_list&ml_id=17&ml_kind=Contact%20Us&order=ASC

- www.financingforum.com

- http://www.techvibes.com/events/upcoming_special_events.a

- Board of Trade events, etc. etc. etc.

Personally, it's rare that a week goes by that I don't meet and entrepreneur who is working on their business (model). These guys are almost always at the pre-revenue, pre-VC stage. Then again, the ability to find 'assets' in the angel phase that meet your investment criteria might be different from meeting entreprenuers who are still working on developing assets, and need more advice than cash.

Basil, I agree with you, I have no issues with early exits.

Also, with the Venture Exchange, when I do speaking engagements about using it, I say it's not an exit, it's just the beginning as it's another way to get the capital you need to execute the BPlan.

The problems with TSXV are when people think of it as an exit strategy! (pump & dump).

Basil - I agree - early works well - but the factors are more than just the internet --- key is the need for lots of money and lots of market reach at that next stage - those buying usually have those in place and have enough depth of knowledge to see the leverage in the acquisition….

An early exit does not mean a lack of belief in the future viability or the growth potential of the Venture. In fact it can mean the opposite. Often the product, concept or idea has a better chance of growing and prospering in a different environment and the synergies, access to capital or expertise that comes from being acquired should accellerate growth.

It is my belief that ideas and concepts and the companies that are created around them, find a natural value level. It is the skill of the management team and the Board of Directors that know when the timing and the partners are right. The decision to take an early exit is usally made by analyzing the risk adjusted value of not selling and the potential for additional value creation in the hands of the acquirer. Sometimes the result is not great for the various stakeholders but often it means that the founding concept and the people associated with it are moving on to greater things. Investors who have been able to make the early exit returns, often invest that capital back into more start up or early stage ventures. This is a good thing and will help to attract more and better new ideas and companies.

The Internet has definitely helped to create this environment where new ideas and comoanies can be "discovered" quickly.

Basil,

When discussing early exit benefits or not, let's first focus on what the objectives of the stakeholders are. If you are an investor who wants to generate returns on your investment quickly, what is wrong-nothing! However, if you are a professional manager who enjoys building a business, see it grow, generate long-term profits, job opportunities, spin-offs etc., the objectives are a bit different. Profit generation, but also long-term shareholder growth and building of base for more opportunities. And if you are a supplier or a local client, again the scenario would be different. And how about a young engineer who wants to join a company where he/she can build a future?

BC is known for small companies, entrepreneurial spirit and quest for quick rewards. Where are our big high-tech companies after so many "success stories"? Far and few between during my 25 years here in BC... The story is that they are many times sold to the American companies that change the Canadian subsidiary to a development house, and in bad times, they get chopped. Maybe good short term benefit for the investor, but where are the long-term visions. Where did the Ericssons, Motorolas, Nokias etc come from. Not from short-term early exits, but long-term ambitions to create an industry, to create a base for expansion. There are some success stories like Creo, Crystal Decisions, Glenayre Electronics, MDA etc., which grew to over the $500 million mark, but they are too far in between.

So just to finish my humble opinion: let's first define what the objective of the investor is, and this dialogue can be very clear.

Mat