All tech entrepreneurs need an exit strategy well before it becomes a realistic scenario. By Michael Megarit.
Most tech entrepreneurs are too busy running their startup to think about leaving it.
In fact, a lot of them can’t fathom the idea of ever leaving the business they founded and nurtured.
However, as strange as it may sound, an exit strategy is just as important as a business plan. Every tech entrepreneur should develop one before launching their business.
Indeed, an exit plan will determine the direction in which the startup will go.
Having the ambition of going public will require a different corporate strategy than trying to merge with another company or selling the business outright.
Further, it’s important that the founder(s) agree on their long-term vision before they launch their startup. This avoids unnecessary confusion and subsequent tensions between founders.
Some tech entrepreneurs are specialized – and most interested – in starting and scaling projects. They aren’t particularly keen on managing large organizations with demanding shareholders and multiple stakeholders. They enjoy launching companies and exiting long before they hit the big time. This allows them to raise the necessary capital to move on to their next ambitious project.
Other entrepreneurs dream of blockbuster IPOs and acquisitions that will make them wealthy. They don’t mind relinquishing control of the company in exchange for equity, a comfortable salary and a seat on the board of directors.
Clearly, these two types of tech entrepreneurs have very different goals and ambitions.
Thus, they need to formulate an exit plan to make their dreams a reality.
What is an exit strategy?
An exit strategy is a plan executed by a business owner to liquidate his position in a financial asset once his objectives are achieved. Essentially, it is the blueprint of how an investor plans to get out of a given investment.
Granted, exiting the startup you founded is an emotional and at times overwhelming process.
Planning for a proper exit ensures a smooth and less painful transition.
However, before crafting an exit plan, tech entrepreneurs must consider the following questions:
- How long do you want to stay involved with the business?
- What are your financial goals?
- Do you have investors or creditors to pay off before leaving?
The answers to these questions will help you craft the right plan for you and your business.
Why tech entrepreneurs need an exit strategy
Most entrepreneurs find developing exit strategies early in the business’ life counterintuitive.
Why would you elaborate an exit strategy when the business is growing and hasn’t fully scaled?
There are 4 main reasons why you must think ahead:
1. Personal health issue of family crisis
Life is full of surprises. In the worst case scenario, personal issues or family problems can hinder your ability to manage the company. Having a well defined exit strategy will ensure the company runs smoothly in your absence.
2. A change in market conditions
The economy is cyclical. Every so often, recessions occur and economic activity grinds to a halt. In these extreme cases, startups and small companies struggle. Some are forced to close while others are acquired by large corporations with significant financial means. Being prepared for such events could give you a competitive advantage over unprepared businesses.
3. Unexpected offers
Large companies are always on the lookout for potential acquisition targets. These companies need to maximize their market share and increase their revenues in order to create shareholder value.
They can approach you at any time and offer to invest in or buy your business. If you anticipate this scenario, you will be able to have insightful conversations with them and make a compelling case as to why your startup is the one they should invest in.
4. Clear goals
Entrepreneurs who craft well defined exit plans from the start have clear goals in mind. Every action they take leads to the finale.
An exit plan guides your strategic decisions and avoids confusion as to the your final intentions.
All tech entrepreneurs need exit plans: Here are 3 to think about
There are numerous strategies entrepreneurs can implement to exit an investment:
- Increase your salary and bonuses until the company runs out of funds.
- Sell you shares to an existing partner.
- Liquidate the company’s assets and use the proceeds to pay obligations and keep the rest.
- Go public through an IPO.
- Merge with another company or be acquired by a larger corporation.
- Sell the company.
- Pass on the business to a family member or a current employee.
However, for most startups, there are 3 common (and desirable) exit plans:
- Mergers and Acquisitions.
- Selling the business.
- Initial Public Offering (IPO).
A merge occurs when a larger company absorbs your startup and integrates it into its corporate structure. An acquisition is similar but involves a corporation buying 50% or more of your business.
Selling the business, as the expression suggests, involves giving up 100% of your shares to the buyer. This is the hardest decision to make as a tech entrepreneur because it means that you remove yourself entirely from the business. However, it also means you get a significant one-time payout.
Finally, an IPO is the act of selling shares of your company on the public markets. Before this happens, you’ll need to raise capital, often through private equity firms. This requires plenty of preparation, fundraising efforts and administrative processes. If this is the path you choose, be prepared for a long process.
How to organize a proper exit
Here are six steps to help you draft an exit plan.
1. Prepare your finances
Investors want to invest in companies with transparent finances.
Thus, the first step to preparing your exit is organizing them:
- Have your accounts audited by a reputable firm.
- Pay all of your taxes.
- Ensure your insurances are up to date.
- Ensure full compliance with regulatory requirements.
Organizing your finances will allow you to proceed to the next crucial step of this process: determining your startup’s valuation.
2. Determine your business’ market value
If you’re just launching your startup, its market value will be close to zero. If that’s the case, you can skip this step.
However, if your business is running smoothly and generating profits, you need to calculate its approximate market value. This is one of the most important steps because it will determine the price you can charge investors interested in buying it. Quoting a reasonable valuation is key to being taken seriously and progressing past the general introduction phases.
Here are five different methods of valuing your company.
3. Asset value
The simplest way to value your business is to add up the value of everything your business owns, such as equipment, inventory, intellectual property, and participation in other companies. Intangible assets such as goodwill also have a (subjective) dollar value that you need to account for in the business’ valuation.
Once you’ve tallied the assets, deduct all debts, liabilities, provisions and obligations.
The final number is the starting point for your valuation. Since a business is much more than just assets, you also need to analyze your revenues.
The second way to value your business is by looking at the annual sales.
Consult an investment bank to determine how much your business is worth given your annual sales.
Be aware that this number can differ according to various criteria:
- Yearly Revenue growth
- Product pipeline.
- Traction of your business.
- Your industry’s CAGR.
Inform yourself to make sure that your valuation is reasonable as per your finances and in line with industry standards.
5. Earnings multiples
A third way of calculating your business’ value is by using a multiple of the company’s earnings.
This metric is called the Price to Earnings (P/E) ratio.
To calculate your company’s value by using a P/E ratio, estimate its earnings for the next several years. If a typical P/E ratio is 10 and your projected earnings are $1 million a year, your company is reasonably valued at $100 million.
6. Discounted Cash Flow (DCF)
A discounted cash flow analysis is a complex but very popular way of calculating a company’s value.
To calculate a DCF, an analyst will look at the company’s annual cash flow, project it into the future and discount the value of those future cash flows to today.
Performing a thorough and credible DCF analysis is a rather complex endeavor.
Thus, you should seriously consider hiring a certified accountant or an investment bank to help you.
7. Non-financial valuations
Finances only reveal part of your company’s story.
A business can also derive value from non-financial data such as:
- Geographical location: well-located businesses command greater prices than businesses located in isolated areas.
- Industry: some industries are highly innovative and at the heart of economic activity. These businesses are more valuable than businesses involved in declining industries.
- Strategic value: does your business provide the buyer with potential synergies that would help them scale their own enterprise? This may command a hefty premium.
- Brand image: do you have a recognized brand with considerable soft power and consumer appeal? This can significantly increase your business’ valuation.
These five methods of valuing your business will help you arrive at a realistic number.
Communicating a precisely calculated value to buyers displays credibility and empowers you during negotiations.
Explore your options
Once your finances are in order and you’ve determined your market valuation, it’s time to consider which exit strategy fits your goals and objectives.
Should you exit by selling to someone you know or an outside investor?
Selling to a close friend, colleague or family member is an easier process than selling to an outsider. However, it is often an emotional process that can lead to tensions in your personal life. Are you willing to let business compromise close relationships?
Do you require professional advice on how to proceed with your exit?
Some startups are complex organizations: they have multiple investors, sophisticated credit schemes, complicated regulatory environments…
Sometimes, it’s almost impossible for tech entrepreneurs to organize their exits themselves.
In the worst case scenarios, unorganized exits can lead to misunderstandings, conflicts and even lawsuits.
If your exit plan is complicated, you should consult with an investment bank or a legal expert to ensure the exit is well executed. Don’t leave anything to chance.
- Consult your investors
Most tech entrepreneurs have early investors on board who helped finance their startup.
It’s vital they are informed about your intention of exiting the business.
If you formulated an exit plan before launching the business, chances are they won’t be surprised you’re planning to leave.
In any case, formulate a strategy that ensures their needs are satisfied. This means making sure they have a say in how the exit is executed, they are kept updated about the process and ensuring their stakes are paid.
- Choose new leaders
Organizing and executing an exit is a time consuming process.
In most cases, you won’t have time to plan the exit and ensure your business’ day to day operations at the same time.
Thus, it’s very important that you prepare your succession.
Identify the people best suited to take over and transfer gradually responsibilities while you organize your exit. That way, the transition of power is underway and your exit won’t leave a power vacuum.
- Inform your employees
Exits can be tough on employees.
Their leader is leaving and uncertainty looms.
Often, employees fear being laid off by the new owners.
It is your responsibility to tell your employees the reasons for your exit and answer any questions they may have. You can also negotiate their status with the future buyer, to ensure they get retrained or receive appropriate severance if they are indeed laid off.
- Tell your customers
The final step of the exit plan is to tell your customers.
Introduce your clients to the new owner and inform them that business will continue as usual.
Along with the business plan, an exit strategy is arguably a startup’s most important document.
It will guide your strategic decisions and help you stay focused on your end game.
If you require assistance, seek professional advice.
About the Author
Michael Megarit is a partner with Cebron Group. With over 25 years of domestic and international corporate finance experience, he provides M&A and capital advisory to high-growth technology companies.