Perhaps the only aspect of your business’s future that is less certain than your 3rd year EBITDA, is the financial exit that you and your investors will experience. But that doesn’t prevent nearly every funding application summary from asking the question “What is your exit strategy”? I’ve come to the conclusion that this is quite possibly the most useless early due diligence question that is routinely asked. And yet, I continue to hear the question at venture fairs, in online investor solicitation forms and in private investor meetings. I believe I audibly sighed the last time I heard it. Which was rude, but heartfelt.
To begin with, founders that have no revenue and are trying to raise their initial funding round haven’t thought seriously one iota about their exit “strategy”. They’ve thought a lot about getting rich from their venture, but they haven’t formulated a strategy for it. They are looking for the on-ramp and you’re asking about the exit 3,000 miles away? If you ask this question during the formative years of the venture, you aren’t focused on the correct things.
Besides, there are basically only 4 types of exits in all reality. 1) IPO; 2) Be acquired; 3) Pass on to your children, and; 4) Go bankrupt. The only credible answer from among these 4 is to be acquired. The investor knows that and so you, founder, should know it too. Suggesting an IPO makes you sound, to me anyway, naive. Suggesting passing the business on to your children makes you sound “lifestyle”. Suggesting bankruptcy makes you sound, well, sarcastic. I personally find sarcasm to be endearing, but I’ve discovered first-hand that many others, sadly, do not. So to be clear, however tempting, don’t answer “bankruptcy” to a question about exit strategy.
I do not mean to say that having an exit strategy is not a good idea in general. There is a time and a place for such a discussion. Perhaps after 3 years of operating with revenue growth of more than 100% per year, and in a dedicated board meeting when a new round of funding is being considered, some serious thought and discussion should occur around the potential exit paths and multiples. That is generally the time that a strategy for exiting can and should be discussed. Until the company has developed at least some operating history and product line evolution and customer buying patterns, it is nigh on impossible to discern what companies out there might make the best strategic acquirer. Oh, there will be frequent brief discussions about exit opportunities, but serious thought about strategically positioning your company for exit will not occur until you’ve built something of value.
Besides, shouldn’t we all be much more interested in your entrance strategy? Well before we talk exits, I want you to tell me about how you’re going to acquire your first customer and increase that to the 10th customer. How are you going to generate positive cash flow. Tell me about your gross margins. How do you get from $0 revenue to $100,000 revenue to $1 million and beyond. Let’s both worry about your exit…later.
Unfortunately, you’ll find that many investors will ask the question. If the question does come up for you, and if I’m in the room when it does, I would stand up and applaud if you answer something like this: “We’ll exit through strategic buyout. But first, we plan to build a fast-growing and cash-flow positive business that fills a market niche that about a dozen Fortune 500-sized businesses do not currently address. When we’ve built that value, and are of a size that is of interest to one of those companies, we’ll explore our options to get the best value for our shareholders in some sort of strategic buyout. For now, though, we’re just getting started.”