How to prepare your tech startup for an exit

Creating a startup and exiting for a big payout is a romantic story told again and again by the internet, media, and forgetful former-founders. In reality, scaling a startup to exit is likely to take a lot of hard work and time.

While the journey to exit will almost inevitably involve life-changing ups, and soul-draining downs, there are things a startup can do to give it a greater chance at success.

One of these is understanding the types of exits that are actually possible (being acquired by Google is not the only one). In this post we highlight some of the most common exit strategies for startups, and share our list of 9 steps to preparing a tech startup for exit.

Most common exit strategies for startups

Merger & Acquisition (M&A)

Mergers and acquisitions typically see similar companies merging together, or larger companies buying up smaller ones. For mergers think Elon Musk’s X.com joining with Peter Thiel’s Confinity to become PayPal. For acquisitions think Facebook buying Instagram, Inuit purchasing Mint, or Alacrity Investor Readiness Program participant Recon Instruments being acquired by Intel.

For startups, acquisition is traditionally a far more likely exit route compared to mergers – while also being one of the most glorified and dreamed about by founders.

Mark Suster sees there being 5 primary types of startup acquisitions – here they are ranked from lowest to highest in terms of likely purchase price:

 

1. 1. Talent hire (the startup’s amazing team finds itself a new home)
   2. Product gap (the company making the acquisition deems it faster / cheaper to purchase an existing solution rather than build something similar from scratch themselves)
   3. Revenue driver (acquiring a revenue-positive company helps to boost the purchaser’s balance sheet)
   4. Strategic threat (typically an established market leader looking to avoid or delay disruption)
   5. Defensive move (if you can’t beat them, make them join you)

 

IPO

Most founders have at some point fantasized about seeing their startup’s logo hanging above the doors of the stock exchange (and the value of its stock exploding) to announce its Initial Public Offering (IPO). Atlassian has done it, Shopify has done it, even Etsy has done it, but startups going public is a much less common form of exit than one might expect.

In 2016 there were a meagre 21 tech IPOs, and 2017 saw only 37. While 2018 may be the year that the tech IPO makes a comeback, the road for startups to go public is certainly not easy. There are significant costs associated with an IPO (perhaps as much as eight times that of raising a series A), along with the risks of stock market volatility, and the time-sink of demanding stakeholders. Once your company is already public, ongoing compliance costs can exceed 1M a year, and there are heavy regulatory controls on what you can say to promote the company. The upsides of IPO can be tremendous, but that potential comes at a cost.

Sale to new owner

As opposed to being acquired by a company, another exit strategy for startups is selling to an individual (or team) wanting to takeover operating and scaling the business (the founder 2.0, so to speak). Ideally this will be someone who has an even greater chance at succeeding – perhaps because of past entrepreneurial experience, education, or other market expertise.

This is a perhaps less-discussed, but very viable option for earning a solid return for both founders and shareholders. Considering the “silver tsunami” of businesses about to be put up for sale by their baby boomer owners, this exit strategy’s increasing prevalence could in turn trickle over into tech.

Cash cow

More of an exit “in spirit” than in the traditional sense, this exit strategy involves enjoying the benefits of a profitable business in the lowest-lift manner possible. First build repeatable processes (or hire great people) to remove oneself from all day-to-day responsibility, next get a copy of the 4-Hour Workweek, and then go enjoy life on the beach. In this case startups are essentially replacing the hard work growth strategy with the ‘cut cost’ and ‘milk the cow’ strategy.

Liquidate

While not the fairytale ending most entrepreneurs (or indeed investors) have in mind when starting out – one all-too-real option for exiting a startup is to shut down, close the business doors, and liquidate the assets.

The need to liquidate could result from a major market crash, significant life event, or a business reaching the point where enough is enough. It’s easy to get trapped by the sunk cost of all that’s been put into a business (time, investment dollars, reputation), but the opportunity cost of running a failing startup should always be considered. It’s important to discuss and explore company values and goals in the early days of a startup, to help guide decisions like these later on.

If only it was enough to simply be aware of the exit strategies available to startups – founder and investor life would be so much simpler (but arguably less exciting). Building an ‘exit-ready’ business involves more than just scaling revenues. Having sound business structures and processes in place from the beginning can help make a startup more likely to successfully exit, and a more successful business generally. Here are some of those structures and processes we encourage our Alacrity portfolio companies to adopt:

9 steps to preparing a startup for exit

1. Start lean

Most entrepreneurs (and even investors) have unrealistic expectations for exit values. The more money a startup raises, the larger its exit will need to be to provide satisfactory returns.

These are two of the reasons both Mark Suster, and us at Alacrity, stress the importance of startups starting lean, and only going fat once product/market fit is established.

2. Build a solid board (or advisory team)

“Learn from your mistakes” is solid advice, but “learn from someone else’s mistakes” sounds even better. Building a solid board of directors (or board of advisors) can help a startup navigate the many obstacles and forks in the road on the way to a successful exit – and it’s important to build this board effectively.

Alacrity and Wesley Clover portfolio companies focus on building boards early on, when there is always a desire to add a little gray hair, experience, and someone who has previously made it in the industry. Saasquatch is one example of a board that adds significant value to the company – with multiple members having gone through major startup exits themselves, including one of the co-founders of Shopify.

3. Be clear on stakeholders’ goals and values

Misaligned, and misunderstood goals and values can lead to trouble down the line for startups.

What do we want this business to become? What does a satisfactory exit look like? Are there certain types of companies we are NOT willing to sell to? These are the types of questions that should be answered, and shared among all key stakeholders in a startup (if not the entire team) from very early on.

A cohesive team working together towards a shared goal is a lot more powerful and effective than a group of individuals striving for separate aims. These types of conversations can be difficult to have, but surely not as difficult as trying to sort out differences during a pivotal moment like a potential exit.

4. Build relationships and leverage PR

The goal is to get on the radar of potential acquirers early, and impress them often. One of the most effective strategies for getting on a company’s radar is to be a fierce competitor, and give that future acquirer so much pain that they feel compelled to buy at any cost. In situations where this is not possible (or to supplement this pain-causing) there is relationship building and PR.

Echosec is an example of a company that is well-suited to gaining press attention, as their social insights platform helps provide intimate information from ‘the most volatile hotspots in the world’. Even still, the onus is on them (as for any company) to maximize this PR potential. Relationship-building goes beyond getting on the radar of potential acquirers too – there are also lawyers, accountants, venture capitalists, customers, and more, who all play a large role in the road to acquisition, and with whom it will be beneficial to have solid existing relationships.

 

5. Get finances under (solid) control

Regardless of its form, an exit is a transaction, and having company finances soundly under control is essential to that transaction being a success.

Andreessen Horowitz recommends having a great CFO as their #1 tip for preparing for an IPO. While in the early days of a startup this role can likely be assumed by someone wearing multiple hats, the importance of solid financial management cannot be neglected.

Potential acquirers and investors want to know that a company has good corporate governance of its finances: that it doesn’t waste money; that its forecasts are accurate; that it has a manageable burn rate this is justified and calculated; and that there aren’t any skeletons in the closet (e.g. tax liabilities, weird cap tables, or outstanding debts).

Certn is one Alacrity portfolio company who seems to have taken this advice to heart, with one of its co-founders and C3O’s being a certified professional accountant in both the United States and Canada.

 

6. Create and document repeatable, scalable processes

Unless a company is purchasing another simply to remove a competitor or gain talent, they will want their acquisition to continue succeeding well after the deal is signed. Similarly, the founders of a startup being acquired may want to be able to move onto new things at some point in the future, without being chained-down by the fact that the entire company’s success relies on their actions.

This is why creating and documenting repeatable, scalable processes (across the entire company) is so important. Evidence that the company can succeed and continue scaling post-purchase makes potential acquisitions more attractive to buyers, can help reduce the required commitment of founders, and leads to a healthier business in general. This also involves building effective scalable infrastructure, such as a CRM, marketing automation, and code repositories.

Tutela provides a great example of creating this type of repeatable process, with their journey taking a content marketing strategy from zero, to millions.

7. Clean up the cap table

A clean cap table is designed to fairly reward the founders (so long as they are still involved), the management team, employees, key stakeholders, and investors. A clean cap table also has a share structure that doesn’t make an acquisition unnecessarily complicated, or require significant spending on legal fees to sort things out.

Any issues with the cap table (perhaps resulting from an early verbal agreement that was never documented, early advisor that never got their shares, or a disgruntled ex-employee) will be much easier to resolve early on, rather than when an acquisition is pending and other parties realize they have new negotiating leverage (such as the panic to sort things out before the acquisition opportunity is lost). Cap table management is important.

 

8. Build a strong data room early on

Any deal (acquisition or investment) will need a data room for due diligence, and this data collection process is made much easier when the right tools and processes are already in place (including CRM, accounting software, R&D, etc.).

A company’s value can depend on the credibility of the hard data it has to support its historical and projected performance and sustainability. The more that can be prepared in anticipation of an acquisition the better, but regardless, company leaders should be prepared (and aware) that anywhere between 30-60 percent of their time will be spent gathering information (rather than running the company) during this time – further stressing the importance of having solid processes in place.

9. Above all else, focus on building a successful company

If you build it, they will come (or you’ll have such a successful company, that you won’t care whether they come or not).

Proactive business activities, along with an awareness of the opportunities that are available, can help a startup maximize its potential for acquisition. From forming a solid board, to effectively managing finances, to creating business processes fine-tuned for growth – we hope you found our recommendations for how to prepare a tech startup for a successful exit helpful for your business (or for a business you know).

 

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We are also very excited to announce that, next week, Alacrity will be releasing the very first episode of our own podcast: Between 2 Termsheets, hosted by Owen Matthews. Between 2 Termsheets discusses early stage investment into tech startups, and the financing environment. 

Episode 1 features investor Tom Williams, and CEO of Referral SaaSquatch, Will Fraser. Stay tuned for next week!