The strategy of successful start-up (and exit)
As a business owner or investor, you will have started out with your business for any number of reasons. These could range from a need to follow your dreams, to seek financial or career independence, to pursue your hobby or passion in life, or to fulfil an ambition to make it into the big league of the business titans – the ones who adorn the covers of well-known business magazines!
Amid all the stress and excitement of getting a business up and running, one of the last things on your mind will be an exit strategy. In fact, the very notion of an exit, just as you are taking the ‘bull by the horns’, may seem utterly counterproductive. Who in their right mind would be contemplating an exit, when they have hardly got going?
Needless to say, there are some very good reasons for every business owner or investor to consider their exit strategy – it needs to be done at the very earliest of stages, and even before the company opens its door for business! Before we consider the various exit strategies, just why is an exit strategy one of the most important factors to plan for, when there are seemingly many more important issues to tackle when starting and running a start-up?
Why planning for an exit is important for every start-up
Most businesses will at some point mature and stall in their growth. The ones that sustain, grow and thrive beyond the prevailing rate of macroeconomic growth are the ones that make it into the big league. Therefore, it is imperative that you have a plan and a view, as to how you are going to get repaid for all the risk, investment, sweat, blood and tears that you have poured into the business.
Seven reasons why you must have an exit plan ready
There are many reasons, beyond any wished-for windfall, why an exit strategy is needed – life is full of twists and turns, some of which are avoidable and some inevitable and in every case, the timing is anything but predictable.
Most business relationships do not end on a positive note, so there is a need for a plan and a view as to why, when and how you will exit – if and when there is an irreconcilable breakdown between you and your business partners. You should plan for this to be a virtual certainty, as most relationships evolve over a period of time and you and your partners will be influenced by a myriad of people and business factors, and people and relationships change accordingly.
Other than the certainty of paying taxes (in most countries!), death is a certainty that needs to be planned for, beyond the obvious critical-man life insurance policies that need be put in place by the business. A concrete plan is called for, which includes a view on how dependent the business is on each of the partners, how their families will survive, and how the remaining partners will be able to conduct the business.
What happens if you or a fellow director is disabled through an accident or due to ill health? Who is going to take care of them, their family, their investments and the business?
When and how do you want to exit the business? How are you going to recoup your investment and tenure in a business that you have started and nurtured, for a period of time? What are your plans to ride into the sunset?
How would you exit your business, if and when a new investment or business opportunity comes your way?
How would you exit your business if you found out a key stakeholder like a partner, was colluding with a customer or supplier or was being deceitful or defaulting on dues to you?
Decline in growth
What are your plans if/when business growth stalls? Do you just wait, bide your time and exit gracefully, forgoing all your hard work, risk and money invested in your business?
Having established the need for an exit strategy, we should tick off a few essentials that need be taken care of when planning that exit strategy. Most entrepreneurs ignore these to their own detriment. It’s unclear if they see them as an unnecessary expense or a waste of time, but if things go wrong or absurdly right, then it is this very set of actions that are going to cover you:
• Have rigorous, fool-proof financial accounting methods, policies and procedures in place, from day one.
• Have a shareholders’ agreement that clearly spells out the rights of each founding partner.
• Create a tiered (preferred) class of shares that enable you to pay out higher dividends and share of profits and one which will ensure that you have higher voting rights.
• Get the power of attorney documents signed by all partners giving you the right to run your business (legally), without undue interference or limitations by other partners.
• In the case of a limited company with a board of directors, get blank board resolution documents signed by all board members.
• Get an appointment letter attested to and signed by all partners clearly stipulating your role as the ‘Chief Executive Officer’ of the company, your salary and tenure.
While these suggestions seem over-cautious, when an opportunity arises for an exit, or when something goes wrong with the business partnership, everyone will really appreciate that you went through the arduous task of getting the accounting and legal due diligence work done. When things go so well or so bad, inevitably cracks will appear in any partnership. The legal protection wrapped around you will pay off big time!
So what are some of the likely exit strategies?
Initial Public Offering (IPO)
IPOs are a rarity nowadays. Of the millions of businesses in the world, only perhaps one in a thousand ever makes it to an IPO. Unless the business has the backing of well-known and solid venture funds with a track record of taking companies public, this is not an option that will touch many start-ups or small businesses.
The process of getting prepared for an IPO is expensive and cumbersome. It involves lawyers, auditors, investment bankers and consultants who are all out for their fair share of meat. During an IPO process, the business and its executives are under the spotlight and subject to various regulatory compliance obligations and audits that you probably never knew existed!
You start off the process by being the ultimate salesman, convincing investors during roadshows with investment bankers that your business is worth much more than it is. By the time the business becomes a candidate for an IPO, your equity will have been well diluted, after the ‘vulture’ funds had agreed to invest in you and your business!
Although IPOs are glamorous and populist of exit strategies, they should not be the first option. Most entrepreneurs are still enamoured by the dot.com bubble at the beginning of this century, but don’t be fooled by these and other IPO stories! That said, for a business which has a unique technology that is well protected by patents, and is funded by well-known venture funds, there truly is potential to win the lottery aka IPO!
Merger or acquisition
Getting another entity to acquire your company is one of the most common ways to exit from a business. The principle is simple – find another business that is ready, willing and able to buy your business, sell it and keep the money and occasionally get paid an earn-out or bonus of some kind, for remaining with the business and helping the new owners run the business that you have started.
Most successful small businesses are acquired by much larger public companies. What this can mean in essence is that you are in a better position than the buyer is. This is so because the folks negotiating and making the acquisition decisions are not vested on their own money but are investing other people’s money. So whereas you will be negotiating a value for all your blood, sweat and tears they are often just ‘employees’ with little to lose.
The recommendation is to get to know as much as possible in advance about the potential acquirer. Then craft the proposition in a manner which suits the potential acquiring company, and is designed to be complementary to its existing business portfolio. The trick is not to limit the exit to one or two suitors. Have an array of suitors and evolve your propositions over a period of time. This way, you have the potential of ratcheting a bidding war among multiple suitors, or at the very least to create a high level of perceived strategic value to a single acquirer.
Disposal, divestment or buy-out to employees, family or friends
If you are a true believer (in your business) and if you are emotionally connected to your business, then selling it to a friendly buyer might be the best option. A friendly buyer could include your family, friends and/or employees who are prepared to invest their own or borrow money for a management buy-out.
Businesses that take this path will not necessarily be doing this for an outrageous monetary exit, but rather to ensure that the quality, integrity and continuity of the business is assured. Very often, entrepreneurs who take this path are not motivated by personal glory or money, but rather are seeking buyers who will preserve what is important to the founder. Equally very often, this is not a functional or rational exit, but rather an emotional exit (which all too often leaves cash on the table).
Bleed to death
There are a few business owners who bleed their company dry almost on a daily basis and pay themselves a chunk of salary and bonus, irrespective of their company’s performance. Some of them give themselves five to ten times the dividends that other shareholders receive. Although these activities are illegal in public companies, they are perfectly legal in private companies.
Cash is king in such companies, and the owners do not reinvest it in their business nor do they consider growing their business. They keep investments down to a minimum and withdraw cash to live off the income of these businesses. For most businesses, cash that is taken out for personal use is no longer available to the business for reinvesting. Where the business plan deems that the company must invest to grow, then, of course, this is not a viable option. There are other ways that a ‘cash is king’ exit could work. You could get your family to loan the business money and pay a high level of interest for the loan. This way the cash is kept in the family, safe from the taxman and away from any creditors and your preferred shareholders.
“Affairs are easier of entrance than of exit, and it is but common prudence to see our way out before we venture in.”– Aseop
No matter what exit strategy is preferred or chosen, it is important to note that the valuation of your company is primarily driven by two factors:
• The cash flow derived from the revenue that the business generates.
• The growth that is being demonstrated year on year.
In this context, it is vital to time and paces any exit to a period when cash flow is maximized (therefore your revenue) and when growth is poised to peak. This is a truism that is applicable in any professional career or business: always exit on a high note! Look around: great business leaders remain great because they exited at the peak of their company’s growth!
JohnLincoln.one — The business growth hacker