A VC in Vacationland

I frequently lecture my portfolio companies (and other entrepreneurs who ask) to always be planning for exit. Why should you be planning for exit when you are trying to raise money to start your company? In simple terms, it is critical to structure your operations, customers, products and sales to make them friendly to your chosen exit strategy.

As Lewis Carroll once said, "If you don’t know where you are going, any road will get you there".  And the probability that you will exit your business before a decade is up is almost certain, unless you decide to make it a lifestyle company, so you better decide which road to exit is best for you.

So what are the likely exit options?

• IPO–Most business plans I see for companies seeking venture financing assume an IPO.  Oh, for sure, the words never appear in the business plan, but the numbers do.  The numbers I am referring to are the revenue projection "hockey stick", where the five-year forecast starts really low, then has revenues reaching into the IPO range, somewhere north of $60 million.  Of course, the entrepreneur is trying to convince potential investors that a real market exists for their idea and revenue level and growth is the easiest way to pitch the story.  I generally advise the entrepreneur to radically scale down their revenue estimates as the truth is no one will believe them.  Only 1% or so of venture-backed companies will have a true IPO exit, assuming we eliminate some pink sheet/reverse merger options.
• Merger & Acquisitions–Bruce Richardson of AMR Research recently had an interesting discussion on M&A exits with John Cooper of Montgomery & Company.  John estimates that 95-99% of all venture-backed companies will exit via an M&A.  While this number seems high, and was not supported by any empirical data in the discussion, the reality is that M&A will be the most likely way you will exit your business. The challenge is what kind of M&A exit will you have? The strategic exit, where an acquirer pays a nice revenue multiplier premium, say 5X or more, for your company’s "must-have" product, technology, platform or business model, is the one most entrepreneurs dream of.  Out of the 95-99% of M&As, perhaps only 5-10% may fall into this category.  The vast majority–perhaps 60-70%–will be a normal exit, where an acquiring company pays a 2-3X revenue multiplier premium.  Perhaps 10% will be some sort of fire sale exit–where your venture backers desperately look for anyone to buy the company, the assets, the IP, or whatever else may have value.
• Close Down/Lifestyle–A small percentage, perhaps 5-10% of venture-backed businesses are just closed down, via bankruptcy or some other shut down process.  Sometimes, the venture backers let the founders or some of the executives "buy out" the investors for cash in or less, assuming the founders have the funds to cut such a deal. Or the investors just walk away from the business, letting the founders turn it into a lifestyle business if they desire.

So, what should you plan for?

I tell entrepreneurs to work like crazy for a strategic M&A exit and hope for a normal one.  Given the probabilities and assuming no one really plans for IPOs or less desirable exits, this advice is the most realistic for most founders.  It’s easy–just design and execute the next "must-have" product, technology, platform or business model.  Of course, it’s not easy, but it’s what you have to do to get that strategic exit.

Am I too conservative?  Are my exit options numbers out to lunch?  Let me know your thoughts.