The 5 Things Most Startup Founders Get Wrong About Exit Planning

Exiting a startup, especially a funded one, means big bucks, right? Multi-million-dollar buy-out stories are a common theme in tech media, but the reality is that these deals aren’t common – and they definitely don’t happen by accident.

In my position at Ramp Ventures, I see lots of companies that have some funding, but that are still undervalued. As a result, when they exit, investors are only going to get some of their money back (and the founder often gets nothing).

How do you avoid this? With a solid exit plan. Before you ever go out and try to get money in the first place, put some time into planning potential exits. Here’s why that’s so important, as illustrated through the most common exit planning mistakes I see founders making.

Mistake #1: They Don’t Plan for Multiple Options

It’s not that you have to have a specific, detailed exit plan from day one of your startup’s operations, but you at least need to start thinking through the different exit options that are likely to be available to you.

Everyone wants to create the next unicorn, but very few companies actually hit that milestone. So if you shoot for the moon and fall short, how are you going to get back to earth – or even just survive in space – until someone comes and saves your ass?

Ideally, you want to have multiple exit options in mind as you’re growing your company. The big question then, of course, is how do you come up with those options? I’ll explore different strategies throughout the rest of this article to help you put your plan together.

Mistake #2: They Aren’t Aware of Their Dilution

Before you start planning different exit options, one factor you need to be aware of is dilution – which, according to the Capshare blog, is defined as, “the loss of value of existing shares due new equity terms.”  

Basically, if you add investors, distribute stock or raise funds, the stake held by each owner dilutes relative to the company’s value, as demonstrated in the chart below from Dries Buytaert:

Because dilution is common for startups, know what’s normal so that you can better predict how it could impact your possible exit options.

VC investor Fred Wilson says:

“In my experience, it will generally take three to four rounds of equity capital to finance the business and 20-25% of the company to recruit and retain a management team. That will typically leave the founder/founder team with 10-20% of the business when it’s all said and done. The equity split at 20% for the founders will typically be; 20-25% for the management team, 20% for the founders, and 55-60% for the investors (angel all the way to late stage VC).”

Obviously, potential dilution of your stake will be highly variable, based on how your business is set up and funded. However, it’s worth keeping this principle in mind, as it can affect the choices you make about your company’s structure and your future exit. For more, I highly recommend Lost and Founder by Rand Fishkin, former Moz CEO, who explains how he walked away with more money selling his company for less than he would have if he’d waited until after the next funding round.  

Mistake #3: They Haven’t Sized Their Idea

Uber became a unicorn based on the universal appeal of its idea. Just about everyone needs a car service at some point, in almost every area of the world. On the other hand, your SaaS product that serves a small audience may never be able to hit the billion-dollar mark – no matter how successful it is – if the market isn’t there.

So how do you know if you have a unicorn idea, or one that’s going to top out at six- or seven-figures? According to the Founder Institute:

“Any market with <10 million people or multiple billions in annual revenue will be very hard to address, and is not worth your time. For example, if you won a $500M market, you would still only have a ~$50M business. You will die winning a small market, so don’t start up in a graveyard.”

Of course, size isn’t everything. Other questions to ask yourself include:

• Do you want to take your company public?
• Have you calculated the total addressable market (TAM) to determine how much demand exists in the market for your product or service
• Are there adjacent markets that can be served by your initial idea to increase your market size?
• Do you have the resources available at each stage to reach your full potential?

There’s no shame in choosing not to aim for the stars. Because the truth is that founding a unicorn and reaching that vaunted status is really, really difficult. It takes more than an idea alone. You’ll need the right people on the bus, with the right funding partners, at each stage of the company’s growth, at the exact right time in your market.

If you don’t have access to these and other resources, there’s no reason you can’t still grow a successful, if smaller company. Just know that doing so affects your future exit options.

Mistake #4: They Don’t Know Different Exit Types

In my experience, there are three basic exit categories (though I’m sure other investors would divide them up into entirely different buckets):

• Strategic, financial exits, through which you sell your company to another company or to a private equity firm
• Fire sales, which occur when you really can’t make your business work, and you’re going to run out of money, so somebody buys you for pennies on the dollar
• Shutting down, during which no sale actually happens – you just discontinue operations

Certainly, a strategic exit is the most ideal outcome for most startup entrepreneurs. Even within this bucket, however, there’s a lot of variability in terms of how this type of exit actually happens – whether you’re bought out entirely, merge with another company, sell off an equity stake or undertake some other type of financial exit.

Fire sales and just straight up shutting down should be on the table for most entrepreneurs as well. Though they’re obviously less desirable, they’ll be a reality for most companies. Knowing this early on will lead you to the decisions needed to minimize their possibility.

Mistake #5: They Don’t Plan Early Enough

Want to avoid a fire sale or shut down fate? The following steps may help maximize your chances of being acquired:

Understand who might acquire you

No, you don’t need to know from day one who’s going to buy your company. But having an idea in mind of the kinds of people or companies that might be interested in your startup will help you make better decisions about your trajectory.

We do this with every company we work with at Ramp Ventures. Even though we aren’t always planning to sell, we’re always thinking about ways we could add value to potential buyers (besides simply adding revenue).

Start making those connections

Let’s look at an example. Suppose we had a new startup at Ramp that we thought we might want to try to sell to Hubspot. Instead of taking a “wait and see” approach, we could:

• Build an integration between our products
• Put together a comarketing campaign
• Sponsor their Inbound conference

Basically, we’d look at the different options we have to get on their radar and make sure they know who we are. This isn’t the kind of thing you can do last-minute. But because we have an idea of who our possible future buyers are, we can start investing in relationships early enough on that they’re already in place when we’re ready to sell.

Improve the company’s position

Exit valuations are impacted by everything from growth, to profit, to debts, to existing talent – and you can affect all of those factors in order to give yourself some protection on exit.

For example:

• Is your team bloated and geared towards fast growth? Or is it growing more responsibly? If you have a particular exit in mind, maybe don’t build a dream team – build what’s next to the dream team.
• Can you cut your company’s expenses? Pay off its debts? Or raise its revenue ahead of valuation discussions? Any savvy buyer is going to want to see that changes you’ve made are sustainable, and not just quick fixes designed to temporarily improve your balance sheet. But if you have several years’ lead time to plan, you can make sure the elements investors will be looking for are already present in your company.
• Have you clearly articulated your product or service’s value? In an article for Inc., Carter and Courtney Reum, co-founders, M13, explain, “Revenue is important, but potential acquirers rarely buy a company for the added revenue. Odds are that the incremental revenue barely moves the needle for your acquirer.”

Rather than focusing on revenue growth alone, Reum and Reum suggest focusing on one or more of the following factors:

• Your distribution model
• Your access to a particular demographic
• Your brand’s strengths

Demonstrating strength in any of these areas makes your value clearer to a potential partner – and as long as you start early enough, you can build one or more of them into your company’s structure.

Don’t Wait to Start Planning Your Exit

Benjamin Joffe, writing for Hackernoon, says:

“Most exits are M&As (CB Insights reported 3,358 total tech exits in 2016–3,260 M&A, 98 IPOs — so M&As are 30x more common), and take place before series B. So prep time starts after seed or A.”

I’d argue that you can start planning even earlier. Having a series of potential exits in mind from the time you launch (or shortly after you’ve established your product-market fit and value proposition) allows you to make educated decisions about how you’ll grow your company.

Your future exit should affect everything from the hiring decisions you make to the partners you bring on. Make informed choices by investing in early exit planning.

Agree or disagree? Leave me your thoughts in a comment below:

Image: Pixabay