We see 1000+ applications a year from all over the country. And, we implemented a screening mechanism to help us A) identify the companies that meet our big picture criteria/deal breakers, B) set the stage for our diligence reports, and C) set the stage for more quantitative work in the future. In the process, we request written questions that lay out a simple abbreviated business plan. We simply don’t have time to wade through a full business plan to decide if we have interest in further conversation with a company. And, a pitch deck does not necessarily give you the information we are seeking. The written answers are incredibly illuminating! They give us good insights into the mind of the entrepreneur. Does the entrepreneur understand the process? Is the entrepreneur coachable? Is the entrepreneur mature enough to be a good steward of our capital? Have they done their homework?
Routinely, when you ask about an exit strategy question, you get a standard answer. That answer is, “I’ll either be acquired, IPO, or provide dividends/buy back the stock. NEWS FLASH! Simply stating the obvious, that being all possible outcomes except bankruptcy, is not a strategy. That’s not 50% of a strategy. It’s maybe 12% of a strategy (shameless Guardians of the Galaxy reference!). When asked for an exit strategy, the proper answer is to pick one of the above and expound on that one as the most likely exist strategy. It’s perfectly reasonable to say, “Of course there are options such as A, B, and C, but we believe A is the correct one because of factors D, E, and F. Therefore, we will proceed with this outcome as our goal.” Much like a map, if you don’t know where you’re going, you don’t know how to get there. A business plan is very similar. If you have a written goal, it is easy to see the steps to get to that end point. If you know where you want to wind up it’s easy to get there. And, there’s nothing preventing you from changing your strategy. But, change your path out of opportunity, not out of ignorance or reliance on some sort of divine luck.
A proper exit strategy might look like this:
“I believe we are going to be acquired by one of these three companies: A, B, or C. They are already acquiring in our space, which is very active right now, with the most recent transactions being: D, E, and F. They were all at a transacted at a G multiple on their top line revenue. These companies need our products / services because we value-add their business model for the following reasons: H, I, and J. Therefore, we intend to continue creating value in the following ways: K, L, and M in order to be acquired by them.”
The less likely, but perfectly valid answer might be:
“We believe we can truly exploit the maximum value of this product / service through an IPO. We believe an IPOs is appropriate because N company already did it. And, they made a lot of money in the public market. We have similar characteristics to this company such as O, P, and Q, and the market looks good for an a public entry by R because of the following reasons: S, T, and U.”
The least likely and most unwanted exit strategy is the buyback / dividend strategy. When we hear this, we simply say, “no thank you,” and move on because high-growth companies do not use their money to pay shareholders. They reinvest in their business to grow it in order to maximize their exit value. To do otherwise is called a lifestyle company. There is nothing wrong with a lifestyle company, but they are not investable by venture-style investors. Buyback is the worst answer you can give an investor because the company will obviously not have the free cash flow to buy back the shares at the targeted 10x return. If it did, it would’ve already been acquired or seeked an IPO. So, if you’re about to give one or both of these strategies to a professional investor, don’t bother. It is a waste of time for both of you.
What you should take away from this is very simple. Put some thought and time into your exit strategy! Do your homework! Convince me you know how to return capital! Ultimately, that is the most important factor of investing; getting a return. When asked for an exit strategy, give a well-conceived, well-thought-out, and well-organized strategy. We don’t want a concept. And, the “all outcomes answer” simply shows naivete, lack of creativity, lack of thought, and lack of preparation. That is a fast way to find your business plan in the digital circular file.
Copyright Eric L. Dobson, 2016