\n<\/p>\n
What do investors care about most? Is it your vision? Your team? How you\u2019ll disrupt an industry and change the world?<\/p>\n
Nope. Those are all important parts of how you\u2019ll be successful. But looking at the big picture, we\u2019re investing to make money. And we only make money when the company completes \u201cthe exit.\u201d<\/p>\n
The exit is when the company is acquired by another company for cash (or public stock we can sell) or the stock becomes publicly tradable in an IPO. The exit is the event that that after many long years of waiting, the stock that we bought in your business is converted back into cash that we can use to pay for our retirement, send our kids to college, or re-invest in fresh startups.<\/p>\n
Until the exit, our investment is dead money. Startup stock cannot be sold or traded. We cannot get our money back. It earns no interest. It\u2019s nothing but a line on a spreadsheet that sits locked up for years. Even if the company valuation skyrockets on paper, there\u2019s no way for investors to convert those paper gains into cash we can use to buy eggs and milk.<\/p>\n
About 90% of our startup investments will fail to return our money. That 1 success out of 10 therefore needs to return 10x for us to break even.<\/p>\n
But we don\u2019t want to wait 10 years just to get our investment back. Given the high risk and lack of liquidity, we want our startup investments to beat investing in S&P 500 index funds or buying real estate. For successful venture investing, we need our winners to return 50x. (More on venture math<\/a>.)<\/p>\n When we ask your exit strategy, we\u2019re asking how you\u2019re going to get a 50x return in 5\u201310 years. If your valuation is $20M now, how are you going to exit at $1B in a very short period of time?<\/p>\n There is only 1 correct answer.<\/p>\n For 99% of startups, the only exit that has the potential for a 50x return is an acquisition by a large public company.<\/p>\n Nobody other than a large public company can pay billions of dollars to acquire a startup. They will pay that much because your startup will open a lucrative new market for them or better position them against the competition. When it\u2019s strategic, they\u2019ll pay whatever it costs. A few billion dollars is a small investment in their future.<\/p>\n But while the correct answer to the exit strategy is simple \u2014 strategic acquisition \u2014 when I ask about your exit strategy, it\u2019s the details I want to know:<\/p>\n The very largest exits are by IPO (initial public offering) that convert private, unsellable startup shares into public shares that can be bought and sold on the stock exchange.<\/p>\n IPOs are great. They offer the biggest returns. But they\u2019re only for multi-billion dollar businesses.<\/p>\n If you\u2019re planning to take over the worldwide hotel industry (AirBnB), taxi industry (Uber), rockets (SpaceX), payment processing (Block), generative AI (OpenAI), etc. your exit will be by IPO.<\/p>\n These current and former unicorns get all the attention, but they\u2019re rare. Last year there were only 9 tech IPOs in the US. In 2023, there were only 6. In 2022, just 4, though during the pandemic bubble of 2023 when the bar for IPOs was low, there were 91. (Data from Crunchbase<\/a>.) Pre-covid normalcy was 30\u201340 tech IPOs per year. (Full data here<\/a>). That\u2019s a miniscule fraction of the tens of thousands of startups founded every year.<\/p>\n If you\u2019re planning to take over a very large industry and have a realistic plan to get to $1B in revenue within 10 years, an IPO is the right exit strategy. For everyone else, an exit strategy of IPO is absurd.<\/p>\n (There are small value IPOs such as the Toronto Stock Exchange or over the counter shares, but valuations are a tiny fraction of the NYSE or NASDAQ and don\u2019t reach the required level of returns, so they don\u2019t count as a successful exit.)<\/p>\n I hear far too many early-stage pitches where the exit strategy is something other than strategic acquisition or IPO. That tells me that (1) the founders don\u2019t understand investor requirements, and (2) it\u2019s unlikely there\u2019s a good way for investors to make a sufficient return from an investment their startup.<\/p>\n The following exit strategies are red flags that scream\u00a0bad investment!<\/em><\/p>\n Acquisition by Private Equity = bad outcome<\/strong><\/p>\n If you reach $20M in revenues and a few million in profits, private equity investors will be happy to snap up the business. Sounds great. Unfortunately, they don\u2019t pay much.<\/p>\n PE typically pays 4\u20135x EBITDA, which usually works out to be around 1x revenues. (Sorry, we don\u2019t believe those spreadsheets showing you reaching 60% profit margins. Reaching 25% would put you in world-class territory.)<\/p>\n Acquisitions by private equity are a common outcome for venture startups, but not a successful one. With PE acquisitions, we\u2019re lucky to get our investment back, much less land that 50x return we\u2019re shooting for.<\/p>\n Acquisition by Later Investors (secondary share offerings) = not how venture capital works<\/strong><\/p>\n Many founders misunderstand how venture capital works. There\u2019s an enduring myth that later investors will buy up the stock of early investors to get them off the cap table. Perhaps that happens in some countries. It doesn\u2019t happen in the US venture world.<\/p>\n Later investors require their investment be put towards growing the business, not giving early investors a big payday. The simple rule for the venture world that keeps everyone\u2019s incentives aligned is that nobody (founders, employees, early investors, later investors) gets anything until the exit where everyone gets a big payout.<\/p>\n Dividends = not how venture businesses are monetized<\/strong><\/p>\n Traditional businesses focus on generating profits and paying out dividends to their owners. That\u2019s a great plan for bootstrapped businesses, but doesn\u2019t work for venture capital.<\/p>\n Venture funds have a fixed term, usually 10 years, after which the fund is shut down. All startups in the portfolio have to be monetized before then. An ongoing stream of dividends creates a mess.<\/p>\n Which rarely matters anyway since it\u2019s exceptionally rare for startups to reach the level of profitability to pay out substantial dividends. If there\u2019s extra cash, instead of paying dividends, investors want it put back into growing the business to reach a larger acquisition.<\/p>\n Management Buyout = doesn\u2019t work for venture businesses<\/strong><\/p>\n Traditional businesses often have multiple founding partners and sometimes a few outside investors. At some point, partners and investors who want to cash out can get bought out by the remaining partners for a few years worth of dividends.<\/p>\n Management buyouts do not generate the level of returns venture investors require and would never be the outcome of a successful venture investment.<\/p>\n Acquisition by Other Startups = not an exit<\/strong><\/p>\n Founders sometimes tell me their plan is to be acquired by another startup. Sorry, that\u2019s not an exit.<\/p>\n For big public companies where the stock can be bought and sold, mergers aren\u2019t much different from acquisitions. But for private startups, the new combined entity is still private stock I can\u2019t sell. The only thing that\u2019s changed is moving my investment from a line in one startup\u2019s cap table to a line in another startup\u2019s cap table.<\/p>\n A pitch to investors is not about how wonderful your product is. It\u2019s a sales presentation where you\u2019re selling stock in your business to potential investors.<\/p>\n Why should we buy that stock? Because we\u2019ll make money.<\/p>\n How will we make money? It\u2019s the exit, when the company is acquired by a big player in the space that is willing to pay a huge premium to add the startup to their business.<\/p>\n At that point, usually somewhere 5\u201310 years after we made the investment, our stock is turned back into cash, hopefully a lot more than when we started.<\/p>\n That\u2019s the reason investors invest, so when you tell us we should buy stock in your business, we need to understand that there\u2019s someone who would eventually buy the stock from us at a price that makes the investment lucrative.<\/p>\n Some VCs don\u2019t want to hear your exit strategy. They declare it a red flag that you\u2019re even talking about exits at all. They\u2019re typically looking at Series A stage startups, where the founders proposing dividends and secondary offerings have already been weeded out. Those VCs are often specialists in your industry and have been through multiple exits of your peers. You don\u2019t need to tell them the comps and typical multiples in your sector \u2014 they know that information better than you.<\/p>\n There are also a few early-stage VCs that want to hear about your world-changing vision that will generate billions in revenues when you succeed. If you\u2019re shooting to take over an entire industry, the exit is understood to be IPO, so there\u2019s no need for discussion.<\/p>\n But for early-stage investors like me \u2014 individuals, angel groups, micro-VC funds \u2014 most of the companies we\u2019re meeting are down to earth, building valuable improvements. They won\u2019t get to tens of billions in revenue; our biggest worry is whether they\u2019ll even reach $50M where an attractive exit starts to become possible.<\/p>\n We don\u2019t know your industry. So we need you to show us that there strategic acquirers who would buy the company at an attractive valuation. We need to see that information in the pitch deck to evaluate the investment opportunity.<\/p>\n As always, know your audience and adjust accordingly.<\/p>\n Katie Deauville is the founder of the teleportation startup, S\u00fcprD\u00fcpr. She could\u2019ve used some good advice on how to build a startup instead of following Elizabeth Holmes and the Theranos model. Find out what happens in\u00a0To Kill a\u00a0Unicorn<\/a><\/em>, the most fun you\u2019ll ever have reading about Silicon Valley.<\/p>\n There\u2019s only 1 correct answer to what matters most to investors What do investors care about most? Is it your vision? Your team? How you\u2019ll disrupt an industry and change the world? Nope. Those are all important parts of how you\u2019ll be successful. But looking at the big picture, we\u2019re investing to make money. And […]<\/p>\n","protected":false},"author":1,"featured_media":315611,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[12034],"tags":[2214,13646,6605,11636,5614],"dealstore":[],"offerexpiration":[],"class_list":["post-315610","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-angel-investor","tag-angels","tag-exit","tag-pitching","tag-strategy","tag-whats"],"yoast_head":"\nThe Only Exit for Venture Investments: Acquisition by a Strategic Buyer<\/strong><\/h3>\n
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The Occasionally Right Answer \u2014 IPO<\/h3>\n
Wrong Answers!<\/h3>\n
Pitching the Exit<\/h3>\n
Important Caveat<\/h3>\n
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