Looking for an exit

25 May 2007

If you're in the early stages of building your company, an exit is probably the last thing on your mind - at least beyond idle day-dreams. But some investors want you to be prepared for everything

What exactly do investors expect from you when you approach them for money? Everyone knows you need a solid business plan, with a comprehensive assessment of the market you're in and a credible explanation of how you can fill an unmet need. You'll need to be able to explain your technology. You'll have to convince them that you have a strong management team. You'll even have to identify your weaknesses. And in some cases, you may need to tell them how they'll get their money out.

Whatever the merits of your proposal - and however dedicated you are to building a world-class business - investors are always going to have one eye on the exit. If they can't see a potential return and a way to get their money out, you're unlikely to win their hearts, minds or wallets. No-one expects you to have pencilled in a date for an IPO - but you will need to be able to convince prospective investors that your company is heading in a direction where an exit is a credible option.

The priority investors attach to exit strategies can differ widely. Anthony Clarke, chairman of the British Business Angels Association (BBAA), points out that angels' motivations for putting money into a company tend to differ from VCs. Many angels enjoy the experience of following their investment and often invest in a business because they know the entrepreneur, so sometimes it will be a less hard-nosed approach than the more formal VC appraisal. That said, he believes angels are getting smarter and beginning to take on board a lot of the same issues that VCs weigh up.

Typically, angels will expect to wait five to six years before they exit from a business - partly because the tax breaks they enjoy from investing may not kick in for at least three years - and will usually expect eight to ten times their initial investment. 'They are motivated to stick with the company,' Clarke argues. 'They are also probably closer to the entrepreneur because they invest at an earlier stage in the business evaluation and they're not under such pressure to exit quickly.'

As managing director of London Business Angels, Clarke says entrepreneurs are asked to discuss potential exit strategies during their investment presentations. They're asked to consider where the company will be in three to five years time, what the attraction will be for a trade sale or flotation, which companies might be interested in buying them, what comparable operations are on the market and what people have paid for similar businesses.

The likeliest exit route will be a trade sale, given that IPO opportunities are relatively thin on the ground, so it's important to keep in mind some of the factors that influence acquirers. In some IT sectors, one key consideration is whether the platform you've developed on is compatible with the acquirer's own technical strategy. It's also worth bearing in mind that the most obvious potential acquirers might not necessarily be the ones that actually end up buying the business - sometimes companies from other sectors will be looking to enter a new market.

Potential acquirers may also be influenced by the company's level of maturity. Some large corporate acquirers prefer to pick up companies where the product is proven and there are a few customers on board to prove demand exists - but they're less enthusiastic about a company that's invested heavily in manufacturing and sales, since it duplicates the infrastructure they already have in place (see Selling Out.

In addition to IPOs and acquisitions, management buy-outs (MBOs) are also a possibility. Ian Cameron, investment director at The Capital Fund, part of YFM Venture Finance, argues that if entrepreneurs are upfront enough to suggest that they might consider an MBO at the end of the investment period, the deal can still work. In fact, even if the multiples aren't as high on exit for the VC, it can actually be a safer bet for the investor. 'I don't have a problem with people being very realistic,' he says.

There are also some very simple questions that entrepreneurs need to ask themselves when it comes to defining the value of their product. Beyond the obvious issue of ensuring they have a working product, they need to demonstrate it's meeting a demand - and equally important, that they own the intellectual property.

Finally, it's worth bearing in mind that your exit strategy may well change as the company evolves. Take Touch Clarity, whose business development director told g2i in November 2005 that the company's ultimate plan was 'to build a business that has the ability to float'. In the end, it was actually acquired by US company Omniture in February this year - for a total consideration of $51.5m. As Cameron points out, this kind of sale demonstrates the need to be opportunistic.

'I can imagine going into a deal where a trade exit is the obvious route, but if the company is in a space that is interesting and there's a lot of appetite among institutional investors. you could end up deciding to float on AIM,' he adds.

By Billy MacInnes, Webster Buchanan Research