Pitch Perfect: The Exit Strategy Is Key

Jeff Loehr, Westchester, NY

February 21st, 2016

Recently at the Westchester Angels we screened a promising company that eliminated themselves with one phrase. When we asked how the investors would make money they suggested we ask our financial advisors. That was the wrong answer and the end of the conversation.

Investors know how they will make their money: through exits. Early stage investors acquire a minority share of the company and rely on the entrepreneurs to deliver value. The investors earn their return only when their share is sold, which generally requires a “liquidity event” or a sale. This means that investors are looking for quick growth and an expedient exit, usually within 5 years.

Even more challenging, early stage investors are looking for a large return, 30 times their investment or more. This is because early stage investing is so risky that even just considering those companies with the potential to generate a 30 times return, most will fail. Investors need a company to generate a substantial return in order to compensate for losses elsewhere.

When investors ask how they will make money, they want to see that the entrepreneur understands this challenge and is thinking about preparing themselves for the sale. They want to know that the company can be sold, that there will be a market not just for the product but for the company itself.

In fact, the market for the company itself is more important. The worst outcome for an angel investor is when a portfolio company becomes a “lifestyle business”. Complete failure sounds worse, but failure has an end. A lifestyle business continues along, earning just enough to keep itself in business, maybe with some moderate growth but with no big future.

These businesses can drain investor’s time and resources and yield very little, generally zero, return.

Most entrepreneurs on the other hand are concerned about earning enough money to survive. Good ones are laser focused on connecting products and customers and filling a need in the market. They are often not thinking about selling the company three or four years out.

But in order to raise money they should think about the exit, right from the beginning.

“I’m a custom quote from this video/photo or maybe just something you want to highlight. Sarcasm always works.”

Those that do often first “plan” for a public offering. But the IPO is the Everest of business growth; many companies start out aiming for the IPO summit but very few will ever make it. It might happen, and everybody would be happy if it does, but it isn’t a strategy.

Instead entrepreneurs should look for logical acquirers of the business. These are companies who are already in the industry space and for whom the entrepreneur’s solution is either a threat or an extension of their product line.

Entrepreneurs should also give an idea of the rate of return generated by other similar exits, by looking at how much companies are paying currently.

Another Westchester Angels company did just this. They identified major food companies with publicly stated strategies of acquiring startups that made products in the same category as the presenter. They showed that similar startups had found acquirers willing to pay significant premiums and demonstrated a pattern of acquisitions. This made their pitch very attractive.

The details of an exit strategy always depend on the situation, but a good exit strategy will:
• Identify who will acquire the company. This should be as specific as possible, the more detail the better.
• Explain why they would be compelled to acquire. The new product may be a threat or a complement to their current offering.
• Give an idea for the price the acquirer may be willing to pay. This will usually be a multiple of earnings. By showing the growth in earnings and applying a multiple, investors can calculate their expected returns.
• Provide a timeline for exit, explaining when it may happen.
• Show a strategy to deliver the exit. This should explain how the entrepreneur is marketing not just to customers but also to future acquirers, making them aware of the startup’s existence.

The clearer and more convincingly this exit strategy is presented the easier investors can estimate their returns and invest.

Entrepreneurs should remember that they are not presenting their cool ground breaking product – they are presenting an investment opportunity in the form of their company. That investment only yields a return when it is sold, no matter how interesting the product may be.

The one mistake entrepreneurs should never make is to tell investors to consult their financial advisors in order to understand how they make money. That will definitely encourage investors to look elsewhere.

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