Platt Perspective on Business and Technology

Building a startup for what you want it to become 5: exit strategies and goal directed strategy and planning

Posted in startups by Timothy Platt on July 27, 2015

This is my fifth installment to a series on building a business that can become an effective and even a leading participant in its industry and its business sector, and for its targeted marketplaces (see Startups and Early Stage Businesses, postings 186 and loosely following for Parts 1-4.)

I began discussing exit strategies in Part 4 in this series, and I will continue that discussion here. Then after that I will move on to consider startups and early stage businesses that would seek to offer the disruptively, innovatively new and novel, rather than simply breaking into more established markets. And as a part of that, I will discuss what innovation means in this context. But before I do so I am going to more fully consider what exit strategies actually are. And in that regard I note that this term tends to be confusing, as it is used in at least two often fundamentally distinct ways, depending on who is using it. More specifically, an exit strategy can refer to:

• A strategically planned out process in which an owner divests themselves of a business, and regardless of its stage of development (a divestiture exit strategy.)

Or alternatively this term can be used to designate:

• A strategically planned out transition with a perhaps even fundamental strategic shift that occurs when a business moves between stages of its development (a development stage-driven exit strategy.)

I began discussing development stage-driven exit strategies as they arise in startup and early stage business contexts in my earlier series: Understanding and Navigating Burn Rate: a startup primer (see Startups and Early Stage Businesses, postings 67-78.) And specifically see these two installments from that series:

Part 11: exit strategies and their implications and consequences 1 and
Part 12: exit strategies and their implications and consequences 2

I will turn back to more directly consider exit strategies in a startup context in this installment, but before doing so I want to clarify this discussion by at least briefly delving into both approaches to understanding and using that term. And I begin that with a straight divestiture exit strategy example, and for an established small business.

The business that I would consider here might be a single attorney law firm with an established practice and client base. It might be a single practitioner medical doctor’s or a dentist’s office. But in any case, and to keep this example simple and clear-cut, consider a trusted professional with a small but successful business and a reliable ongoing repeat business customer base. And this professional is getting on in years and is approaching a point in their life when they want to move on from their work and retire. What are their assets, and particularly their assets that might be of particular business value to a younger professional who would seek to open their own business? What does this soon to retire professional hold as business assets that they could sell off, for a profit that would go into their retirement funds?

• Their client base is one obvious source of at least potentially sellable value. How transferable is this, from one practitioner to another? How much effort would the outgoing business owner expend in helping a prospective buyer of this business to effectively retain its pool of established clients?
• As a second source of potentially transferable good will, does this outgoing practitioner/business owner have solid working relations with supply chain partners and for business supplies, new business referrals or other value creating accommodations? To pick up on office supplies, or required business consumables in general, has this business entered into agreements that would offer better prices or faster delivery or other benefits? And can they be transferred over to a new business owner as part of a business sale?
• Does this retiring business owner have reciprocal referral sharing arrangements with fellow professionals, and could this be made transferable through networking assistance and introductions?
• How easy would it be for a new owner, and perhaps newcomer to the area to match these sources of value, and how long would this take them? If you look at this in terms of marketing and related costs for building comparable systems of relationships from scratch, plus loss of potential revenue over the period in which these business-supportive relationships are being built, as measured against prudent expectations of revenue that might be expected from buying these resources, how much would these good will sources of value be worth to a business buyer who seeks to take over an established firm, or alternatively start from scratch?
• Research is important here, where a prospective business buyer needs to have three realistic scenarios in mind when, for example, calculating the value of buying a client list as part of making a business acquisition and practice takeover. How many of a selling business owner’s client list, as a percentage, are likely to stay on through a business ownership transition of this sort and how many would be expected to drop away and move on to deal with a competitor? Use a standard three-scenario approach here with a normative scenario, a worst acceptable case scenario and a best realistically possible case scenario and with all of these alternative possibilities thought through in some detail and with all of them based on comparable business ownership transfers. (Here, I mean “as arguably comparable as possible” and for location and the type of community setting in place, practice size and specialization and so on.)
• Get to know this person who is selling their business. I have seen this type of transaction succeed where the seller did in fact act in good faith and help, for example, their successor in business ownership retain as many of its established customers as possible. But I have also seen at least one situation develop where the business seller in fact actively spoke out against the buyer – he was ambivalent about divesting from “his baby” and acted out on that to the detriment of all.
• Know what this seller actually thinks about this divestiture and about making the life changes that it will lead to. If they are ambivalent about this, and certainly if they come across as even just slightly resentful of the prospect of losing their business, any potential buyer should beware. And even if they do end up buying this business and taking it over, they need to know up-front precisely what they are and are not buying and they need to make sure that they are getting what they have explicitly paid for and particularly for those perhaps all-important nontangible assets.
• And of course any tangible assets have to be considered here too, including the office space that this business occupies and the building it is in and whether they are owned by the seller and would be included in the sale, or rented and if so on what terms. Would rent or lease terms be transferable, and if not what would the new costs of this be? What about renovation? What would be needed and at what likely costs, and if this is a rental property who would pay for what portions of it and how would this capital improvement impact upon lease terms? (Once again, at least two or three bids should be sought out and with all of the due diligence effort in selecting bidders that would be called for when planning out any significant renovation job.) And that only partly addresses one possible area of the overall physical assets list that might be under consideration, where specialized office equipment and more, might also be up for discussion.

I could just as easily have selectively dissected out some of the working parts of a business acquisition into an already established acquiring business here, and particularly where the original owner(s) and leadership of the acquired business are leaving after this transition, and whether that would be immediately or after the end of an agreed to transition period. Divestiture exit strategies can and do arise in any of a wide variety of ways. And one point they all have in common is that transitioning them always requires carefully planned out strategy and operational execution and on the part of both buyer and seller.

That last detail: the need for carefully planned out strategy and operational execution applies just as fully to development stage-driven exit strategies too, and I pick up on my earlier-cited discussion of these events with that in mind. And I begin that with a brief four scenario list of transition goals that a startup or early stage business builder and owner might pursue, that I initially offered in my above-cited earlier series in its Part 11 where a founder and owner might seek to:

1. Maintain their business themselves as a privately held, wholly owned entity.
2. Go public with it as an initial public offering (IPO).
3. Sell their business for incorporation into another, probably larger business through merger and acquisition processes – building an M&A target of opportunity.
4. Bring in angel and/or venture capital investors for accelerated growth out of early stage and into what would be hoped to be significant profitability.

First the obvious:

• Three of these scenarios (numbers 1, 2 and 4) involve the founding owners staying on and as leaders of their new businesses, with the remaining (number 3) represents a divestiture scenario where a startup founder or group of such founders would seek to build a source of value and then move on from it, profits in hand for their risk taking efforts.
• Two of these four scenarios involve owners relinquishing what can be significant portions of control and decision making authority in exchange for externally sourced funds that can be used for business growth and development (2 and 4.)
• There (in Scenario 2), when a business goes public and takes on shareholder investors it has to meet whole new sets of legal and regulatory oversight requirements and it has to follow new sets of ongoing due diligence-supportive business practices as well.
• And when a business brings in angel and/or venture capital investors to accelerate its growth and development (as in Scenario 4), its founders and owners have to relinquish at least selective and agreed to levels and types of control in exchange for this funding. And this at least traditionally holds particularly strongly when that business seeks to bring in higher investment level (e.g. venture capital) investors who generally require board membership and who also often want a voice in selecting key members of the business’ executive team (e.g. their choice of Chief Financial Officer.)

All of these scenarios and others that can and do also arise have at least one key point in common. If you want to pursue one of them as a long-term goal when setting up your new business from its day one, you need to prioritize what you build in that business accordingly, and when. Just to pick one detail for each of the four, by way of example:

1. If you want to pursue scenario 1 from above, you need to build for all-around strength and stability. And that includes building and maintaining reserves as would be needed for what might be slower than expected initial growth.
2. If you want to pursue an IPO you need to build with priorities that can facilitate development of early marketplace buzz and marketing strength; you need to build with a goal of both proving your new business is stable, and with a goal of marketing it as a break-away value as an investment.
3. Scenario 3 of my above numbered list calls for a type of selective business development and business marketing approach too, so in some respects this is like Scenario 2. But here, your focus is not on drawing in large and small-scale shareholder investors who would buy in and then wait to see if they want to hold onto these shares or not. It is on building with some certain type of overall business buyer in mind, or even with some specific single business in mind that might be brought to acquire this new venture as a whole. If this is your goal as a startup founder, you need to build what you can present as a unique, and I add uniquely valuable new innovative capability – that you can market to potential acquiring businesses as a capability that they will need to have in-house, and before their competitors can gain it. Many small cutting edge technology startups take on this exit strategy goal for its potential quick profitability and even if they do not explicitly start that way from their earliest pre-build planning discussions. It is always possible to at least work towards transitioning from a Scenario 1 or from a Scenario 2 approach to this, as a new business forms and as opportunities faced through it become clearer. (Note: businesses acquire smaller businesses for a variety of reasons, but startups and early stage businesses rarely have market reach expanding customer bases or other established business qualities that would make them great potential acquisitions; if they are good acquisition targets it is essentially always because of innovations that they might be able to offer.)
4. And pursuing Scenario 4 means knowing what types of due diligence requirements outside investors would require, and knowing how they would impact on the running of and development of a new business. And more importantly, and particularly for working with venture capitalists, business founders need to know and understand their prospective investor partners’ exit strategies too, and how a founder’s and an investor’s exit strategy might differ – and particularly where a founder wants to take a long term perspective in building business value where an outside investor might be looking for more of a quick profit. Here, a new business founder who wants to build towards bringing in outside investor support, has to build their new venture with a goal of bringing any investors who might become involved in this, into agreement and alignment with them for the goals and priorities as to where this business would go. This scenario is in some significant respects like Scenario 3, insofar as you as a founder need to know your potential outside investors as one of your core due diligence requirements, just as a pursuer of Scenario 3 has to know their potential acquiring businesses. And in both cases, the more you have already developed your new business and the more solid value you already have in place in it, the more favorable the terms you can reach in coming to agreement with these outside forces.

I am going to turn to consider innovation in my next series installment, as noted above towards the top of this installment. Meanwhile, you can find this and related material at my Startups and Early Stage Businesses directory.

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