Most entrepreneurs wait too long to start thinking about their exit.
They usually sell their companies for much less than they could have. The valuation curve, and return to shareholders, usually ends up looking something like this.
That’s exactly what I did in my first company. (It was the first time I lost several million dollars, and the first of many similarly expensive - and valuable - lessons about exits.)
Most of the technology companies I’ve known well exited too late. Yes, most. "Riding it over the top" is by far the most common exit scenario.
The fundamental cause is simply our fundamental human natures.
The goal of this article is to help you time your exits better.
How Long Does It Take to Sell a Company?
Depending on who you ask, and whether they are trying to sell you something, you will get different answers on how long it takes to sell a company.
The time to exit depends a lot on the company - primarily on how long it will take to get the company into a saleable state, and then how much time the senior team has available to work with the M&A advisor.
A good rule of thumb is that it will take 6 to 18 months from making the decision to completing the sale. That means to execute the best exit, the decision to sell has to be made 6 to 18 months before the peak in the selling price.
Selling Price Depends on Internal and External Factors
Selling an entire company is similar to selling shares in the public markets - how much you can get depends on how the company is doing, but also on how the overall market is behaving. For many stocks, the overall market is a bigger factor than how the company is actually doing at any point in time.
This ‘external effect’ is even more pronounced when an entire company is being sold because the market for companies is much less ‘efficient.’ The term inefficient includes a lot of aspects, but the important effect here is price. This post describes market inefficiency and how you can use it to your advantage when selling a business.
At the end of 2008, near the bottom of the most recent debt bubble collapse, the overall stock market had dropped about 50%. If there was a similar index for the value of entire companies being sold, I am sure it would have gone down much farther than that, and stayed near the lows much longer. This is, in part, because the market for entire companies is much less ‘efficient’ and therefore more susceptible to changes in sentiment and liquidity.
The Macroscopic Economy Affects Every Exit
The overall economy is often the most significant timing factor in an exit. This means you’ll also need to consider what may be happening in the global economy 6 to 18 months into the future.
My first exit was sub-optimum because I hadn’t seen the previous debt bubble forming back in 1990. If I was paying attention, I might have noticed that most of my cable TV company customers were using a new financial instrument called ‘junk bonds’ and that S&L’s were financing too many real estate projects. Heck, I didn’t even know what an S&L was - let alone a junk bond.
We are all familiar with the effects of the macro economy. In the M&A business, the future condition of the 'micro' market is almost as important.
The Micro Market for Your Company
The state of the micro-market you will sell the company into is the second biggest factor in choosing the optimum time to exit. Markets for companies are notoriously inefficient, and the valuations for a given type of company can easily vary plus or minus fifty percent in a year depending on perception and supply and demand.
If a space becomes ‘hot’ valuations can be several times higher than just a year earlier. These micro market conditions can often affect price more than the fundamentals of the company.
The micro market is often easier to predict than the macro economy. For example, I recently met with two bright, local entrepreneurs who are building a company in an exciting niche market riding on a long term trend. These two young founders chose their space well and were already global leaders in their niche. They had prototypes in the market and a respectable global mind share.
Their niche was heating up quickly - unfortunately for them. In the previous six months, I’d read several articles in finance blogs or newsletters about yet another company that had just been financed in their specific vertical. Most of the financings I read about were for $5 to 20 million. This local company has been built on something around $1 million.
This is a scenario I’ve seen about a hundred times before: too much money flushing into a space the VCs think will be hot. Too many companies being founded with exactly the same business plan.
These entrepreneurs were too young to attract the amount of capital they’d need to compete in this new environment. They had only two strategic options - an early exit or hiring a ‘name CEO’ who just might be able to raise a big enough round in time. I recommended an exit because I knew the money flowing in to their space would also increase valuations - possibly by 2 to 5x over normal ranges.
You can probably guess the young entrepreneurs wanted to wait a ‘little longer.’
Most CEOs don’t have time to keep up with the macroscopic economy, or the micro markets for selling their type of companies. They need advisors who have the time to stay current on the big picture and help them incorporate these market effects into their exit strategy.
Under Appreciation of Exits as a Strategy
Selling the business is an under appreciated business, and life, strategy. CEOs make important strategic decisions every day - often subconsciously. Most CEOs have never executed one exit and only a very few have done two. This inherent lack of familiarity results in exits being a very underused strategic alternative.
Most CEOs miss their optimum exit window simply because they haven’t been thinking about their exit and haven’t built alignment on an exit strategy. (I wrote about exit strategies in the previous edition of the Acetech Newsletter.)
Selling the company is also a life strategy. During my two decades in YPO, I got to know many successful CEOs. I watched many of them sell their companies. The exits were always a milestone in their lives and in every case I’ve been close to, the exit was a very positive event. And it was not just the successful exits that were positive life events - even the exits that might not have been considered a success by some of the investors were always positive events for the founders and CEOs.
I have come to believe that founders, executives and investors would all make more money, and have more fun, if we understood exits better and utilized exits more often as a business strategy.
And Largely Human Nature
I don’t want to be too hard on the young entrepreneurs I wrote about earlier. They were mostly victims of human nature.
They just couldn’t think about selling because they were having too much fun. They were leaders in their market and big companies were enquiring about huge orders. They knew their revenues were getting ready to grow – and possibly explode.
Unfortunately, they couldn’t appreciate that it was also the absolute best time to sell their company. In fact, they should have started the exit process 6 to 12 months earlier.
Human nature also affects the buyers. They will always pay the most when everything is going perfectly and the future looks even brighter. The buyers’’ human nature also means that a skilled M&A advisor can usually sell for a lot more based on the ‘promise’ rather than the ‘reality.’
Human nature also works against the entrepreneurs on the downside. The reason human nature ends up costing most entrepreneurs, and their investors, a lot of money is because most of the time CEOs and boards wait until it’s pretty clear that the company’s value has peaked before starting the exit process. By the time the buyers get to the serious price negotiations, it’s also clear to them that the company’s best days are behind it. And another 6 to 18 months has passed, which has usually allowed the trend to extend even further. The result usually ends up looking something like the graphic above.
When you do an Internal Rate of Return (IRR) calculation for an investor, the difference can be dramatic. Using the hypothetical example from the graphic above, an exit in 3 years at a 5x return works out to an IRR of 124%. If the company waits until the peak, then starts the process, and ends up selling for 2x at year 6, the IRR is only 15%.
With exits, like many things in business and life, timing can be (almost) everything.
Video of "How Not to Sell a Business - Don't Blow the Biggest Deal of Your Life"
If you’d like to hear more about everything I did wrong during my first exit, and avoid some of my expensive lessons, this is a video of a talk I gave the to the Vancouver Entrepreneurs Organization titled: "Don’t Blow the Biggest Deal of Your Life".