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At a recent gathering of startup founders, I was surprised to find that none had given much thought to the exit. Some didn\u2019t even understand what I meant when I asked about their\u00a0exit strategy<\/em>. And most were perplexed that I cared about an exit that won\u2019t happen for years from now while they were still developing their product.<\/p>\n They were certainly surprised when I told them that as an investor, the only thing I cared about was their exit. I was surprised that they were surprised because, well\u2026the only thing that matters to investors is the exit.<\/p>\n If that isn\u2019t obvious, if you aren\u2019t working the business plan and investor pitch backwards from the exit, then you don\u2019t understand how startup investments work. And if you don\u2019t understand what investors want, in fact, our entire motivation, then you aren\u2019t going to get any investment.<\/p>\n The problem, the product, the go-to-market, the team? Everything in your pitch, every question we ask you, is ultimately about how you\u2019re going to turn our investment into a big return at the exit.<\/p>\n The exit sounds dramatic, and it some ways it is. It sounds like the death of the business, and sometimes it is. It sounds like the founders are exiting, and sometimes they do, but usually not.<\/p>\n The \u201cexit\u201d is the shorthand term for the event when the stock in the company becomes traded or tradeable. In more concrete terms, it means when the company is acquired or does an IPO.<\/p>\n In an acquisition, the stock of the business is purchased by another company. In an IPO, the stock becomes publicly tradeable. The\u00a0exit\u00a0<\/em>is when shareholders (including investors, founders, and employees) are able to exit the ownership of those shares and turn them into cash.<\/p>\n Until then, we\u2019re locked in. Until the exit, our investment is nothing but a line on the cap table. It pays no dividends; pays no interest. We can\u2019t get the money back. We can\u2019t sell it to anyone else (with the exception of unicorns preparing for an IPO, in which case are ways to sell it.) From the day we write a cheque, all investors can do is wait for that exit.<\/p>\n If I invest $1M in Apple shares, I can sell them at any time. If I buy a house, I can sell it within a few months. If I buy a Picasso painting and decide I want to buy a racehorse instead, I can put it up for auction. If my wife insists on buying a second home in Japan, I can sell my bitcoin holdings or my Apple shares to finance it. A startup investment? Can\u2019t sell it. Can\u2019t do anything with it. Can\u2019t even use it as collateral for a loan.<\/p>\n Whether the company is doing well or not, doesn\u2019t matter. Whether the valuation has gone up or down doesn\u2019t matter except for bragging rights. That investment in your startup can\u2019t be turned back into cash until the exit.<\/p>\n Since this is an investment, we\u2019re expecting a return. But there is no return until the exit. The two most important numbers for investors are therefore:<\/p>\n An investment in your company isn\u2019t just competing with other startups \u2014 it\u2019s in competition with the S&P 500, with treasury bills and corporate bonds, with real estate, with crypto. With higher risk and total illiquidity, you\u2019re going to have to beat every other alternative.<\/p>\n The challenge of venture capital is that 90% of startups fail to produce a return. 50% fail outright. Another 40% return 1x or less. That means the 10% that do succeed, need to do so spectacularly.<\/p>\n To break even, we need that 1 success out of 10 to return 10x. To beat the S&P 500 over 7 years, we need it to return 25x. Include dilution from later rounds of funding and you need to return 80x. If your company is valued at $10M in the current round, you\u2019ll need to reach an exit of $800M.\u00a0This article<\/a>\u00a0goes into details of \u201cventure math.\u201d<\/p>\n For venture investors, there are only 3 types of exits. <\/p>\n An IPO is an ideal exit. Valuations are high. But an IPO requires a company to have revenues approaching if not already well over $1B. If you\u2019re making GenAI infrastructure or AI chips, an IPO is possible. If you\u2019re developing an AI-based app, it\u2019s not.<\/p>\n There are only a handful of IPOs each year of the very biggest unicorns. For 99% of successful startups, the exit is an acquisition.<\/p>\n There are lots of different reasons for an acquisition that I will discuss in my next articles, but it\u2019s generally either a\u00a0strategic acquirer<\/em>\u00a0\u2014 an operating business, usually an industry giant\u2014that wants to get their hands on the startup\u2019s product, technology, customer base, or team, or it\u2019s\u00a0private equity<\/em>\u00a0investing in cash flow and profits.<\/p>\n Private equity will buy any company that\u2019s making solid profits. That generally does not include venture-backed startups. And the amount they pay is a small multiple of operating profit. Not the sort of returns venture investors are aiming for. A PE exit is usually great for a bootstrapped startup and a failure for a venture-based one.<\/p>\n Getting someone to pay $1B for a startup generating $100M in revenues and losing money at it can only be a strategic acquirer. And not just any strategic buyer but one with a billion dollars to spare and a sense of desperation willing to pay through the nose to take over an arrogant upstart.<\/p>\n Why would a company pay $1B to buy your startup? It\u2019s not just to get a new product or access to a new technology. It\u2019s because you\u2019re stealing their customers and now they\u2019re forced to protect their cash cow. Or you can open a new market for them that they can\u2019t get into themselves.<\/p>\n How many companies in your market fit that model? Perhaps 2 or 3. That\u2019s your exit strategy. Take their customers, steal their market share, and force them to acquire your startup at an absurd valuation to avoid facing irrelevance.<\/p>\n That\u2019s more than building a good product and finding customers. It\u2019s a strategic attack on a giant rival asleep on the battlefield. But you won\u2019t wake them up until you reach $100M in revenues. Anything less than that is a bug to be stomped on, if they even bother to look at you. That\u2019s why your revenue plans have to be to reach at least $100M, and why the SOM has to be in the billions.<\/p>\n This isn\u2019t an easy game to win. The odds are stacked against you. But this acquisition or IPO has to be the end game. This is what you\u2019re playing for. If you don\u2019t plan from the beginning with this end in mind, you\u2019ll be headed down the wrong path. It\u2019s like trying to play chess without knowing the goal is to capture the opponent\u2019s king.<\/p>\n If you\u2019re pitching to investors, we need to know your exit strategy. We need to hear your plan to get to that huge pot of gold over the rainbow, even if we know there will be lots of detours along the way.<\/p>\n I\u2019ve heard many VCs say they don\u2019t need to hear a startup\u2019s exit strategy, and in fact that can be a red flag for them.<\/p>\n On the other hand, early investors including angels like me need to hear the exit plan, and the lack of one is a big red flag.<\/p>\n What explains this seeming discrepancy?<\/p>\n By the time a startup has reached Series A investment when VCs typically begin writing cheques, companies without a viable exit strategy have already been weeded out.<\/p>\n If startups are talking seriously to VCs, their revenues are growing rapidly and they\u2019re in an industry with a history of M&A, or are targeting a giant opportunity that makes an IPO viable. At that stage, the details of the eventual exit matter far less than revenue growth rates and expansion plans. It\u2019s all about execution.<\/p>\n At the earlier pre-seed stage, the pitch is all about potential. It\u2019s all about the plan. We hear a lot of pitches from startups with niche products that are unlikely to grow large enough to attract suitors prepared to shell out billions, or are in industries with little M&A activity.<\/p>\n So if you\u2019re looking for early-stage investment, make sure your pitch is a clear plan for how investors will get a return at a big exit.<\/p>\n If you\u2019re looking for early-stage venture investment, check out my two investment groups:\u00a0Chemical Angels<\/a>\u00a0for startups innovating in chemistry and materials, and\u00a0Tech Coast Angels<\/a>, a sector-agnostic angel group.<\/p>\nWhat Is the Exit and Why Do We Care So Much?<\/h3>\n
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How Big of an Exit is Required?<\/h3>\n
Types of Exits<\/h3>\n
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The Fight over Exit Strategy between VCs and Angel Investors<\/h3>\n