Where’s the Nearest Exit? 

Venture capital is a long-term investment strategy that is designed to generate extraordinary returns and outperform other investment strategies.  The equity that an investor owns through investing is illiquid, meaning it cannot be readily bought or sold as there is no explicit marketplace to do so.  Therefore, in order to monetize the investment, investors seek to capture equity appreciation over time and extract that value creation through a liquidity event, also known as the exit strategy.

There are a variety of exit strategies for private companies with the most common being a partial or complete sale of the business, or through an IPO.  Given that successful IPOs are far rarer, and most appropriate for later stage companies, most investors focus on selling the business as an exit strategy that can be achieved much sooner. In this scenario there are one of two types of buyers for a private company:

• Strategic Buyer

• Financial Buyer

A strategic buyer is another, usually larger, operating company in the same or similar marketplace and would seek to create value through acquiring the target business.  This buyer is considered “strategic’ because of the motivation to acquire a company to achieve greater benefit for the buyer in the future.  This could be through achieving operational synergies, such as consolidating to a single marketing department instead of operating two separate ones and realizing cost efficiencies as a result.  It could be to acquire a certain customer base or product set, or even to acquire a specialized and high performing management team.  Because of ongoing synergies that are realized by the buyer, a strategic buyer typically will pay more for a company than a financial buyer.

Financial buyers, on the other hand, acquire ownership in a business to capture the economic value of the cash flows from operations.  They will look to the free cash flow of the business and use financial structures (such as leverage) to generate returns on their investment.  Private equity funds are the most prevalent financial buyers and many times will buy and sell a business at various stages throughout the company lifecycle.

The “what” of an exit is a sale and the “how” is to a strategic or financial buyer.  That leaves the “why” to be answered.  The answer is in defining an exit as a “strategy.”  The strategy to follow to build a company and run it as a lifestyle business is much different than what you would do if you otherwise wanted to build a company to grow and create a meaningful liquidity event in the future.  The majority of companies that are attractive to direct investors are businesses that can achieve an exit in the future.  This means that the management team, and investors, will have a plan to build the company, achieve goals and growth metrics to make the company attractive to target buyers in the future.

On the part of the owner, this requires an understanding of what the target buyer may find appealing down the road, and incorporating those characteristics into the company’s growth strategy.  It is not uncommon to start working on an exit strategy two years in advance of when the target exit event is planned.  This means that building value in the company over the life of the investment becomes part of the broader corporate strategic plans.

Click this link to view an example profile of a medical technology company at exit. Use this same template to think about the future state of your business and what it will look like.

In summary, know where you are going and have alignment with your investors as to how to create a return for the investment based on a feasible exit strategy. Each company is different, so if you plan to build the elements most relevant for your specific company to maximize your future value, the benefit is both having a road map to follow, and the discipline to not chase “opportunities” that aren’t aligned with the plan!