Join us this week for the final seminar in our 2011 seminar series, Start at the End: Exit Strategy with Basil Peters of Fundamental Technologies II and author of Early Exits. His presentation begins at 6pm tonight and it will be live blogged and tweeted for those unable to attend (and future reference for those who do!).
Basil says that the best strategy for a startup is an exit strategy.
Entrepreneurs have complex motivations, he observes—why do you do what you do? Investors, on the other hand, are simple minded: they want capital gains. They’re also a pain in the ass, he admits (he is one himself). They demand documentation, board meetings, and of course their money back… which means you need to have an exit strategy.
Exits are Basil’s favourite part of the entrepreneurial life, as they’re so fulfilling and rewarding. But they’re also complex and confusing, filled with myths and misperceptions that are “dangerously wrong” to the entrepreneur, plus a few “dirty secrets.”
IPOS AREN’T THE WAY
Two ways to sell your company: an IPO, or an M&A. (Initial public offering, merger and acquisition transaction.) These days, there are very few IPOs since 2000. M&A has become the prominent way of exiting. The media distorts M&A exits, Basil says, by focusing on multi-billion dollar deals. Ironically though, these don’t work out for the buy—think YouTube (Google), Skype (Microsoft), and Flip video cameras (Cisco). Slowly, corporate America is figuring this out. So what does that mean for you, the smalltime entrepreneur? It means smaller M&As are ripe for the picking—small and fast exits that slip under the radar but still equate to big profits and successes for you.
SMALLER IS BETTER
The median price of exits is below $15 million. Why are there so many smaller transactions occurring? Because big companies aren’t good at new ideas or startups. They suck at building new sub-businesses. But they excel at growing companies that are already established and sizeable, and make them even bigger. They want companies under $100 million is out of the “sweet spot” to buy—they like companies worth $20 million. It’s simpler to acquire and easier to profit from.
In fact, many big companies are spending more on M&A and internal R&D. Some companies like Google prefer companies “pre-revenue”—startups with less than 20 people, worth less than $20 million, generating as little as NO revenue.
Cisco, Google, Microsoft, Apple, Oracle, and Intel all have between $18 billion and $40 billion in cash. This isn’t a good thing—cash doesn’t grow. Shareholders pressure these companies constantly to put this money to work. How? All-cash M&A of small innovative satrtups.
But it’s not just big companies snapping up the tiny fish. Medium sized companies are also aggressive buyers, especially public ones. Even many wealthy individuals not ready to retire are now eyeing up these startups, and grouping up to buy them. In fact, there is so much demand so little supply in this space that there can be bidding wars.
WHAT WORKS TODAY
1. Small companies innovate, bootstrap.
2. Angels and friends and family finance.
3. Big companies buy them.
4. Buyers grow the business from there.
How does an entrepreneur get to stage three? Prove your business model. It’s as simple as a spreadsheet that shows real results for basic metrics such as gross margin per customer, cost of customer acquisition, etc. Here’s the kicker—you do not have to be profitable!
Basil goes as far as today this is the optimum time: get out while you have momentum, while no major glitches are occurring, before you peak and then decline. Sieze the opportunity, carpé diem. Don’t let human nature “defeat” you—AKA let your ego overtake sensibility. If in doubt, look to sell before you think the prime time is. Don’t forget, the selling process can take six to eighteen months.
THE INTERNET SEA CHANGE
The internet has accelerated everything that we do. The startup lifecycle is no exception. An entire company can be built in a weekend (this has become almost a sport amongst entrepreneurs now). A true example is of a company being built in literally one day in London and it was sold in just 10 days over eBay. Nano-sized website-based are sold all the time on Flippa.com, too, for sums in the tens of thousands (or even hundreds!).
Other examples: Flickr sold for $30 million after 1.5 years. Delicious sold for $30 million in 2 yrs. Club Penguin sold for $350 million 2 yrs. YouTube sold for $1.6 billion at 2 yrs old. AdMob sold for $750 million at 3.5 yrs old. Mint sold for $170 million at 3 yrs old. Playfish sold for $275 million for at 2 yrs.
RAISING CAPITAL. FROM WHO?
Financing used to be much more necessary and much more tedious. Companies cost millions of dollars to build, no matter the kind. Now, you can use your own resources largely. Bootstrapping, Basil says, is the best way to run your company—and this is coming from an angel investor. Capital efficiency is the new name of the game.
However, not all companies can be bootstrapped. Basil asked the audience: who is planning to raise capital from VCs? Who from angels? Who will boostrap? Fascinatingly, no one plans to use VCs, while about a quarter plan to use angels, and roughly half intend to bootstrap—much different than even 5 years ago, where VCs still dominated.
VCs invest about $20 billion per year in America. Angels also invest roughly $20 billion. But friends and families invest five times more than either!
While raising capital still is and probably always will be difficult, there is a surplus of capital nonetheless floating about.
Entrepreneurial DNA is different than Investor DNA. For this reason Basil advises entrepreneurs to create an exit strategy before financing their company. You must understand that different investors are compatible with different types of exit strategies, so select investors whose DNA mingles well with that of you and your exit plan. An investor vehemently opposed to the entrepreneur’s exit strategy can be a severely detrimental conflict down the road.
Ultimately, the exit strategy is just another business process. And it can be simple. In its most basic form, “Our exit strategy is to sell our company in X years for approximately Y million dollars.” THis can be expanded on, maybe to half a page, but it doesn’t have to be. This concrete clarity works wonders even as a single sentences. Make sure you have investors and partners and shareholders to sign this exit strategy and formally check its alignment annually (if possible, have everyone re-sign it).
SUMMARY
1. Most acquisitions are under $15 million.
2. Modern companies require minimal capital.
3. Bootstrap your company if you can; if not, use friends and family.
4. Angels before VCs.
5. Optimum exit strategy: target your exit for under $30 million.
6. Start at the end!
QUESTIONS
Q: How can you be so general about the $30 million exit?
A. We’re working with statistics here, the median of M&A transactions etc. It’s not an absolute fact that every exit should be this size. I am generalizing in a huge way but the reality is that most acquisitions are this small or much smaller, so my advice to plan for something within that range.
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Q: What about Apple and Microsoft? Did they have exit strategies?
A: Their exit strategy was to file an IPO, raise massive capital, and scale.
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Q: Can I lower my price to sell my company faster?
A: It depends on a great number of factors. The problem with selling as fast as possible can create problems that price reductions simply cannot speed up. Due diligence must be done. Wealthy individuals can close fastest, private corporations somewhat fast, and public companies very slow.
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Q: Are “weekenders” really selling a company or just an idea?
A: They’re not selling ideas. Ideas are nearly impossible to sell. Even weekenders must prove their business model with fundamental metrics.
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Q: If my company isn’t approached by buyers, how do I get on their radar?
A: If buyers come knocking on your door, it’s usually bad news for the sellers. Why? These guys typically have their performance rated by how little they buy your company for. They come to negotiate a low price with you before anyone else knows you exist. They’re professional and sophisticated at this game and not your ideal buyer.
The truth is that most of the time sellers must reach out to potential buyers. And it’s a good idea to have at least three buyers bidding on you.
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Q: When looking for a buyer, do I look for a buyer within my industry?
A: It’s all about strategic fit. You’ll more likely find a willing inquirer within your industry, but regardless of industry, make sure they have a strong balance sheet and an history of acquiring smaller companies.
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Q: Does having debt change my exit strategy?
A: Warren Buffet once said “There’s nothing inherently good or bad about debt.” Having some debt won’t change much for the buyer in most circumstances.
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Q: What are deal breakers when it comes to exiting?
A: CEO makes the mistake of trying to exit it himself without experience. Entrepreneurs should seek outside professional help. Deals also fall apart on represenations and warranties a lot—more than price.
Have an exit team including the CEO, an experienced attorney, and an M&A expert. Use the latter to actually sell the company, not the attorney or CEO.
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That’s it!