Platt Perspective on Business and Technology

Planning for and building the right business model 101 – 13: exit strategies, entrance strategies and significant business transitions 3

Posted in startups, strategy and planning by Timothy Platt on October 5, 2015

This is my 13th posting to a series that addresses the issues of planning for and developing the right business model, and both for initial small business needs and for scalability and capacity to evolve from there (see Business Strategy and Operations – 3, postings 499 and loosely following for Parts 1-12.) I also include this series in my Startups and Early Stage Businesses directory.

I listed four business transition scenarios in Part 11 of this series that can arise as a young enterprise transitions out of its early development stage, and into becoming a profitable business, which I repeat here:

1. Maintaining your business yourself as a privately held, wholly owned entity,
2. Maintaining your business yourself as a privately held entity but with a restricted set of shareholders in the form of angel and/or venture capital investors backing you,
3. Going public as an initial public offering (IPO), and
4. Selling your business for incorporation into another, probably larger business through merger and acquisition processes,

Then I devoted that installment and Part 12 to a discussion of the first, default scenario of that list. I stated my intent to proceed with a discussion of the second of these scenarios after that, and finally turn to address that here, and as a variation on the default approach.

When the founders and owners of a new business set out to retain total, exclusive ownership of their venture, they can and generally do take claim to the overall planning and execution that go into it. Ultimately, they are the ones who make the final overall decisions and they are the ones who hold overall, ultimate responsibility for the outcomes and consequences reached, and both for the positive and successful, and for the more problematical. Scenario 2 can be seen as a variation on this default business approach where these assumptions are systematically challenged.

Whenever an outside investor steps in to make a significant investment in a business, and certainly as an early capital development funds providing investor, their expectation is that they will have a say in how that investment is used and how that business is going to be run, as a requirement for their meeting their own due diligence requirements.

• Investors, and larger individual funding source investors in particular, seek to both make a profit and to protect their investments so as to reduce their risk of loss.
• Angel investors tend to move into a new business earlier with their investment support, and they often do so as much because they see value in its business objectives as they do because they see this as a source of personal return on investment. And they are less likely in general to make significant demands as to how the businesses they invest in are organized and run, operationally or strategically. They often make business investments that per-investor run into the thousands and even tens of thousands of dollars to put that in scale.
• Venture capitalists make what are generally orders of magnitude larger investments that can extend up into the millions of dollars. And they base their investments on much more through and far-reaching due diligence and risk management evaluations and both of the new businesses they might invest in and of the people building them. Venture capitalists often specialize in the types of business and industry they invest in, focusing on areas where they have developed specific expertise, and they tend to see these ventures essentially entirely as personal profit generating opportunities.

I readily acknowledge that some business owners actively seek out “non-voting” investors who will invest funds but without securing a voice in the building or operations of the businesses that they invest in. And crowdfunding: financial support from large numbers of individually small investment level participants, as a more modern twist on this, shows that it is possible to raise substantial amounts of investment capital in this way, and certainly when leveraging the value potential of online social media for doing so. (See alternative finance for further material and references on this and other capital fund raising approaches that a business can pursue, as means of raising funds it can build from but without relinquishing any real control over their venture as a trade-off.) I will return to this categorically distinct form of outside funding in an upcoming installment and note it here, strictly as a point of contrast to angel and venture capital funding, and to venture capital in particular. The key here, is that no individual investor here is making a substantial investment of any sort, so they are not individually assuming any significant risk, in the event that they lose their investment from this new business venture failing.

Angel investors, and venture capitalists in particular make very large individual investments by comparison, and assume correspondingly significant levels of personal risk too, as a direct consequence. I am going to devote the balance of this series installment to consider in at least some detail, what types of voice and control venture capital investors in particular ask for in exchange for their funding support. And I will also discuss the pros and cons of this, from the business owner and founder perspective, for the businesses that are so invested in.

• Venture capitalists, as noted above, are generally expertly familiar with the specific industries and markets that they invest in, and venture capital investment businesses generally have industry expert teams that both vet and select specific new business ventures to invest in and who then work with them, to improve their odds on gaining significant returns on the investments they make in them.
• These investors want to have a say in the drafting and organizing of the business plans these new ventures develop and work from, to make sure they do not have gaps or inconsistencies in them.
• They generally deeply understand and appreciate burn rate: the rate that funding at hand, pre-revenue and pre-profitability is expended (see Understanding and Navigating Burn Rate: a startup primer, as can be found at Startups and Early Stage Businesses, postings 67-78.) And they generally know from direct experience how quickly a new business can burn through the investment funds that they provide it with too. So they take a very cash flow and revenue-oriented approach and both in what they require from a venture’s founders as to how they build a business, and in how they allocate and prioritize, and I add time their spending. It is common for venture capitalists to want to select a Chief Financial Officer, and one who has specific experience working with and managing the funds of new young businesses, to safeguard their own investments there, and their profits potential.
• Venture capitalists do not generally seek to supplant or control other positions in a new venture, but they do look for people who have experience and who they feel will listen and learn from them. And with this advisory role in mind I add that it is common for large level investors such as venture capitalists to want one or more voting seats on the board of directors to a new venture they would invest in too – not the board chair position generally, but positions there that would have positive influence and that would be actively listened to.

And this brings me to the issues of what this type and level of control and oversight offers a new business’ founders and owners, and both for its pros and cons. I will continue this discussion from that point in my next series installment. And then I will proceed to address scenarios 3 and 4 from my list at the top of this posting. I will address all three of these scenarios in terms of what a business is to build into, as it leaves its early pre-reliable profitability stage. And as promised above, I will also turn back to more fully consider crowdfunding and alternative funding as noted above here.

Meanwhile, you can find this and related postings and series at Business Strategy and Operations – 3 and also at Page 1 and Page 2 of that directory. And you can find this and related material at my Startups and Early Stage Businesses directory too.

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