Platt Perspective on Business and Technology

Understanding and navigating burn rate: a startup primer – 11: exit strategies and their implications and consequences – 1

Posted in startups by Timothy Platt on November 11, 2011

This is my eleventh installment in a series in which I have attempted to unravel at least some of the complexities of resource bases and burn rates for startups (see Startups and Early Stage Businesses, postings 67-76 for parts 1-10.) And with this installment I bring the overall discussion to a point that can be seen as a transition stage out of being a startup, and even out of being an early stage business per se – exit strategies.

There are two resources that I want to begin this installment by noting, and one of them is Part 10 of this series where I discuss possible angel and venture capital investors. A decision to bring in either would constitute an exit strategy in and of itself. I initially discussed their involvement in a business venture in this series from a very different perspective, insofar as their participation would align with and be part of a larger stakeholder picture for the developing organization. Here, I will look at them from the exit strategy and business stage transition perspective per se.

The other resource that I would start this installment’s discussion by citing comes from a posting that I added to an earlier series on this blog where I wrote about online businesses and their exit strategy options. The basic options that I listed there, angel and venture capital involvement included, would all at least potentially apply to any startup or early stage business as its founders and owners planned out their long term strategies. And to recapitulate them here, with their initial order changed for purpose of this discussion, startup founders and owners face four basic paths that they can develop towards:

1. Maintaining their business themselves as a privately held, wholly owned entity.
2. Going public as an initial public offering (IPO).
3. Selling their business for incorporation into another, probably larger business through merger and acquisition processes.
4. Bringing in angel and/or venture capital investors.

My goal here is to explore some of the issues involved in planning and executing towards an exit strategy, from the perspective of the startup’s or early stage business’ financials.

Building a privately held, wholly owned entity:
The first option on my list can best be seen as the basic default model and approach. According to this strategic plan, founders would build symmetrically with resources developed and expended to uniformly build for stability and growth. The goal here is to build all of the features, structures and operational capabilities needed to run and maintain an independent business as a significant participant in its communities and in its marketplace. The other three options, according to this reasoning can all be viewed as strategically planned-for deviations from this model, with intentional skews in what is built for and with what priorities.

Building to go public through an IPO:
From a financial structure and cash flow perspective, this may be the most divergent alternative option to the first that is on the list, and certainly if these options are considered completely separately from each other. The primary reason for that can be found in regulatory oversight requirements that businesses need to be ready to meet if they are going to go public. The Sarbanes-Oxley Act is definitely a consideration here, in the United States, but most countries place at least some restrictions on visibility, accountability and the meeting of specific minimal accounting standards particular to businesses that would be publically traded and owned.

This directly impacts on how liquid funds and monetizable assets are identified and listed, and it impacts on how, as a matter of operational processes, funds are expended and how that it accounted for in the books. Basically, this drives development of an active finance department that might very well be more complex and comprehensive than would be done, and certainly in the early stages for an option one business. And it imposed a particular type and depth of finance department support.

I will add that this calls for more extensive legal council support too and with its active decision making involvement in more issues than would be called for in an option one approach. So this brings in more restrictions on how the business would be built than just greater up-front expenses too.

Building an M&A target of opportunity:
In option one and option two scenarios, a new business venture’s founders and owners build a business that is intended to stand on its own, and to borrow a word from my option one notes above, do so with a measure of symmetry in development and development priorities that would facilitate that. Here, the goal is a bit different as it calls for planning and development with the needs of potential buyers in mind.

According to this scenario a new business venture still needs to be stable and systematically organized enough and for all basic features and services to grow into an attractive acquisition. But the founders and owners of such a venture need to really understand and build in terms of other organizations – focusing more specifically on presenting what they do as a unique value proposition capability that can fit smoothly into another business’ operations and strategic plans. They have to know the marketplace that they would bring their new business venture to as their product.

This means thinking through and developing the value proposition that the new venture would offer if it were simply to remain a stand alone business, so that it would fit into another business’ core model too. What is this startup doing and what does it seek to offer as a unique and uniquely valuable product or service? How would that capability round out and complete another business’ offerings and uniquely help it reach its strategic goals in capturing and retaining market share? With option three, the founders and owners take on a very particular context that they would have to build their venture into, if they are to succeed. And here, options one and two become alternative plan B approaches that would be pursued until this option three works out.

Angel and/or venture capital investors:
I have already written about a number of features of this option in series installment 10 so I will focus here on one key detail that comes into play here that definitively shapes a new business venture’s strategy and planning, and their operational execution – certainly for issues of liquidity and funds available, and for cash flow.

• Angel investors and venture capitalists infuse funds into new business ventures as investments, and they generally seek to garner significant returns on those investments and on shorter time frames.

It can be very significant to strategy, planning and operational execution that venture capitalist groups insist on putting a chief financial officer in place who meets their due diligence and risk remediation needs – and this can be a very positive factor for all concerned. Their offering specific and focused advice and guidance as a means of increasing their own chances of success can and often does translate directly into that startup or early stage business having a greater chance of success for its founders and owners too. But overriding all of this is that timeline and time frame requirement.

A venture capitalist has to keep their investable funds moving to keep them effectively working for them and bringing in revenues and profits. And this can force a new venture that is willing to pursue an option four approach to also plan for and build for an option two or an option three exit strategy too. Here, going IPO with the sudden cash influx that would bring, or selling the venture to a larger third party, with its sudden cash or cash-equivalent influx would meet angel and/or venture capital investor needs. And if this is a very successful venture, it would enrich the founders and owners too. And I add that most studies would give that outcome perhaps a 10% chance of happening, and that just considering the new ventures that would meet venture capital investment quality requirements. Overall and considering all startups and early stage businesses, that level of success is much rarer.

Venture capitalists have to be prepared to walk away from failed ventures as a cost of buying in on the success stories that more than make up for any loss coming from the almost made it cases.

I have just outlined the basic options that founders face as to exit strategies. I am going to finish this series, at least for now by reconsidering exit strategies more specifically from the perspective of those founders and owners, where the above notes look at these processes from a more outside-in perspective.

You can find this and related postings at Startups and Early Stage Businesses.

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