Planning an exit strategy? Don't waste your time

I agree with most of what you say Divesh. The only part I would disagree with is the comment about the "Unknown solution." I think every business needs to start with a problem to solve. It can be a simple problem or a complex problem but if you are not providing a solution to something you probably don't have a business. You may stumble upon it later but that is a dangerous way to play the game.

Hi Brad, great comment and my bad for not being clearer. I don't mean that entrepreneurs should raise, and investors should invest in, blind pools where you kick around and figure out what to do. I agree that you need to start by trying to solve a specific problem, but that iteration creates new insight into all kinds of problems that you may not have thought of. And chances are that you may end up solving a completely different problem and still be successful. The odds of knowing which problem you are trying to solve at exit is low, but that doesn't imply that you shouldn't be solving problems at inception. Hope that is clearer!

Thanks Divesh. I totally understand. I thought your post was excellent.

Ironically I am currently consulting for a Venture Capital group on a deal and the entrepreneur could use your advice. He is so focused on what he thinks the business opportunity is he is missing the real opportunity (in my view) that is in front of him. The reason in his case is that his real business opportunity is probably smaller then his original plan. Typical. However his failure to adjust may ultimately be fatal.

The key point - and your point - is that entrepreneurs need to be nimble with their business. You need to accept that the market will ultimately decide your business and you need to learn to go with the flow instead of stubbornly clinging to an unproven vision.

I agree with both Basil and Divesh :)

I don't think both strategies of "thinking about an exit early in the game" and being "nimble/flexible when running your startup" have to be mutually exclusive. One can help define the other. At the end of the day, for a startup, knowing ALL possible options and scenarios and choosing the optimal one from them is what matters.

Like Brad, I agree with a lot of what you say, Divesh, - that a company strategy has to be nimble and adapt to the changes in the road of a start-up. I have also read Jessica’s book and take issue with the changing business models for the companies you reference, but we can debate that over a beer sometime.

More importantly, I’m writing because I take issue with the thrust of your article, which is that planning an exit strategy is a waste of time, since your business will evolve as you refine your value proposition and target market. You make the assumption that since your business model has changed your old exit strategy is worthless.

But wouldn’t it make more sense to adapt your exit strategy along with the plan?

I have sold over 100 companies for clients and a few of my own. I have worked on many sides of the table – selling my own business; selling a client’s business; buying a business for a client; selling equity to a VC; buying equity as a VC. I’ve seen a few transactions from a variety of angles and can tell you that understanding the motivations across the table are the most important thing you can do to complete a deal on favourable terms.

Understanding a buyers’ motivation means calling them and asking them what deal metrics they favour. For example, I was doing the prep to sell a company that maintained firewalls and networks remotely. We called the companies consolidating that space and asked them the valuation metrics they favour and most said a range close to 2 times revenue (with a lot more “it depends on…” that is tangential.) When we dug deeper it turned out the best ones - with an M&A team and multiple recent transactions – would pay 4 x firewall maintenance, 2 x other recurring revenues, and 1 x services and equipment. It all averaged to about 2 x total revenue, but when my client learned that firewall maintenance is worth 2 to 4 times the other revenue streams he was shocked. Because it was just as easy to sell as his other services. He took the business off the market to build that sector of his business. And he will ultimately sell his company for far more as a result.

I have dozens of examples like this. The best situation is when people plan for an exit at least a couple of years in advance of any transaction so there is time for the results to hit the financial statements which will be used to value the company. I have made presentations to New Ventures BC, UBC, SFU and BCIT called “Plan your Exit from the Outset”. It might mean driving revenue growth for the first couple of years then favouring profits for the last two. It may mean selling assets that aren’t contributing enough or adding geographical sectors or target markets. It means learning what your buyer favours to get the best terms for all your hard work.

The time it takes to change your plan – and I mean properly plan that change – is far less than the time it takes to change your exit strategy. If you fail to understand how the changes to your business model affects the valuation of your company, you are missing a crucial step in your planning process.

Unless you want to keep the company for your kids. Not that there’s anything wrong with that. Just not as exciting.

BTW, I know Basil Peters quite well and can confirm, he’s a good guy. I think this is what he is driving at.

Hi Dave, we may be in violent agreement, or not, as the case may be. I think planning an exit strategy is a waste of time UNTIL you decide to exit (which should only be done when you have something to sell). Then of course you should plan it, and the way you suggest makes a lot of sense. (I have done a few hundred million dollars worth of software equity transactions in my career and share many of your perspectives).

The point is for entrepreneurs; namely, they should focus on building a business, making the turn to profitability and generating cash flow. Then they can have an exit pretty much any time they want to (and then start planning for it). I have met with one too many small companies whose entire strategy is to get bought by X, Y or Z. That kind of exit strategy thinking strikes me as pretty silly.

Want to exit early? Bless you! Want to turn down offers because you think you can scale? Bless you too! But don’t build your business to an exit, just build your business!

I have sort of a middle ground position. I don't think it is necessary to have an exit strategy in mind when you begin as I agree with Divesh that this can distract you from coming up with the best business model for you business.

What I advise is that you always prepare your company for an exit by building a solid foundation for your business. You do this by keeping a solid balance sheet, making sure all of your key agreements and IP are properly papered and building a strong value proposition into your core competencies. If you can do this then you will not just have an exit strategy but options for an exit strategy which is ultimately where you want to be.

Thoughts?

Preparing an exit strategy from the get go is not mutually exclusive with building a business. In fact, in many ways, I believe that it focuses an entrepreneur into building up a proper entity. While I won't mention the dreaded 'M' word, this falls into the same pool of strategy: How is this venture going to be worth money.

Ask the majority of entrepreneurs who have sold their business, and you'll get the same answers: they wish they'd prepared for it earlier. Divesh, you have a valid point in that every company should be focused on cash flow; this is very true, and something that the majority of startups fail to go after. Where I'll disagree with you is that all it takes is for cash flow to have a sound exit "whenever you want." Who, when, and for how much are all tricky parts of the equation, and should (at least in a rudimentary form) planned for from far earlier than the point that an entrepreneur realizes they want to sell.

I think the point of Basil's argument isn't necessarily that Day One there's a big exit strategy (We will be valued at 5 million, with $0 in monthly revenue, to an exit in the telecommunications sector, etc). It's that entrepreneurs are often unwilling to take an early exit because they haven't even considered it. By preparing for the offer, they're less likely to go for the pie in the sky valuation and buyouts, instead seeking out realistic sale opportunities at all stages of a company's growth cycle.

Great post, Divesh. I am glad that my efforts in trying to get entrepreneurs to think about exits is starting to create some buzz. But I'm a little disappointed that I have not been able to convince you that having an exit strategy is in the best interests of entrepreneurs. I also hope to help entrepreneurs appreciate that good alignment around a formal exit strategy is essential right from startup and certainly before contacting the first external investors.

I wish you, and everyone reading this, could have been at the March 9 workshop on Exit Strategies for Angels and Entrepreneurs here in Vancouver. It was a full day event with 12 speakers and over 50 attendees. It was an incredibly successful day with an amazing amount of information and excellent dialog on every aspect of tech company exits. The good news is that Riiplay.tv recorded the whole day and it will be available online soon. I’ll make sure there is a post on Techvibes when it’s ready.

I agree with your point about companies changing their business model along the way. It’s actually fascinating how often that happens in successful companies.

But I suggest that the exit strategy is actually a more fundamental element of the corporate DNA than the product strategy. Let me use an example from one of your companies. According to your bio, you were CFO, President and CEO of Pivotal. It’s a great example of a company that changed its product strategy. As I have heard the story many times, when Norm Francis founded the company and got the first investors to invest, it was for a pen based computing product.

Norm was too early and when that plan didn’t work, he didn’t wind up the company, but instead kept the same investors and tried plan #2. Norm did the right thing... the honorable thing. He did not abandon his investors and just do a new startup. Instead he went to his investors, told them that the first plan was a bust and asked for their patience and more capital. The plan worked brilliantly.

The interesting point to me is that while his first product plan did not succeed, his exit strategy and financing strategy did. Here I am assuming that you agree that the exit strategy has to precede the financing strategy. (But I am willing to admit that I did not understand this until years after I sold my first company.)

While I was not there, history would indicate that Norm’s original exit strategy was to do something big, that would take a lot of capital and plan for a big exit. I base this assumption on the fact that Norm did raise a lot of money and did a good sized IPO. My strong belief is that the early investors in Pivotal invested, in part, because they believed that Pivotal would do a big exit. I hope this illustrates my point that the exit strategy has to precede the financing strategy.

It’s difficult in just a few hundred words to do justice to something this complex, but I hope I have incorporated your very valuable point about companies changing their product strategy along the way.

I believe the most important thing of all is to have an open, thought provoking dialog - a free and constructive exchange of ideas. That is one of the reasons I speak at conferences and contribute to Techvibes and my own blog.

Divesh, I look forward to your case study posts and the continuation of this excellent discussion you’ve started.

@brad don't worry about the exit, but always be ready for it, I agree completely.

@lyal "Who, when, and for how much are all tricky parts of the equation, and should (at least in a rudimentary form) planned for from far earlier than the point that an entrepreneur realizes they want to sell." Actually, they should only be planned when you decide you want to sell, and then you should assume that selling will take sometime between 6 and 24 months, during which time you can prepare (if you aren't already prepared like Brad!)

By the way, aren't there any entrepreneurs out there that actually want to take over the world rather than selling their companies? There must be a Junior Gates, Jobs, Zuckerberg, Ellison, Dell out there somewhere in Techvibes land!

@divesh 24 months is a fairly long run way for a startup to have to reasonably prepare, particularly if they get an offer earlier than expected.

Thanks Divesh. I appreciate your ruminating on this, but I'm missing your point and I would have to agree with Basil. According to many start up and entrepreneur "How-to" books, if you don't have an exit strategy, it's almost like not having an executive summary for your business. Did the entrepreneurs in your example not have an exist strategy AT ALL in their business plan? While it's expected and almost inevitable that a business that starts off– let's say A will end up being a B an so on, that doesn't mean you don't need to plan for an exist strategy. Whether it's a tech company or a tech product that you're building, you need to give yourself an out, monetary or otherwise. Unless you want to be working IN the business forever and not doing something else..like crushing grapes with your bare feet in Tuscany when it's all said and done. I don't know, I'm just saying.

@basil thanks for the comments. I will talk about Pivotal (as well as three other companies in my next post on this). I think the important point to note here is that Kleiner and Oak expected Norm and Keith to create a big business, and by virtue of doing so, create some kind of exit. After all, they invented Accpac before they started Pivotal.

@lyall 24 months is a long time! but I didn't say it would take 24 months to prepare (if you have your stuff in order, it can be really quick, like a few days). But if you decide to sell, it's going to take 6 to 24 months to get the deal done (and the longer it takes, the worse off you are). A great outcome is when you are not planning an exit but you are ready for one (as Brad suggests, that is good corporate hygiene anyway), and someone comes along with an offer earlier than expected. And a great way to get an offer earlier than expected is to be heads down building the business and not worrying about the exit!

@victoria building a profitable business IS an out. and by the way, what is wrong with working IN the business forever? Bill Gates and Larry Ellison didn't complain. And Steve Jobs did only when he couldn't work in his business. Back to my closing "if you focus on building a business, you will eventually make money, but if you focus on making money, you may not end up doing either." Follow your bliss. Make a business. Water it. Grow it. Live happily ever after.

LOL.. seems like I'm bit of a lightweight here given the 100s of millions of dollars worth of transactions everyone has successfully completed! I think Brad has got it right though - the fundamentals for any business need to be in place to create options for exit - whenever that may be. Think about it, but certainly don't obssess.

I started a relatively risky venture recently and found it quite useful having an exit strategy if only to demonstrate how the value could be extracted by business partners and investors later. I'm pretty certain the potential partners were not under any illusion that the timing and elements of the business model will change iteratively as the venture unfolded - I think it was important for them to see a credible endpoint.. I think it certainly helped convince them to jump in.

Divesh, to your point though since the partners have been in place, I have not toyed at all with the exit strategy and have been focusing on business development. Quite frankly there just hasn't been time to focus on anything but! No business, no exit - it's as simple as that.