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What’s your exit?

OVP Staff
March 12, 2011

Entrepreneurs have usually developed stock answers for most standard VC questions by the time they meet with us.  We typically wait until the end of a pitch to pose one deceptively tough one – “What is your goal on exit?”

As I have said before, everyone on our side of the table has read everything that the entrepreneur has provided, so we rarely spend much time on the prepared pitch deck.  Instead, we go right to Q&A.  Needless to say, most of our discussion educates us, to the extent possible, about the technology/business to be funded.  That is the body, so to speak, of the essay.  However, we still have an introduction and a conclusion to contend with.

For us, the introduction is the most important and interesting part of most first meetings.  This is when we ask the entrepreneur to tell us about him or herself.   This answer (depending on the number of managers present, and the nature and depth of their experiences) can take 10-30 minutes, by the time we are done exhausting our curiosity.  These interactions are, from our part, entirely unscripted and often lead to unexpected insights.  If the entrepreneur is experienced, we tend to dig into lessons learned, particularly lessons learned the hard way.  If the entrepreneur is a first timer or otherwise relatively inexperienced, we like to understand how deep the entrepreneurial current flows, and sometimes find ourselves learning about high school start-ups, family business backgrounds or other first signs of a restless spirit.  We avoid dime store psychoanalysis, but we pay close attention during this time (and throughout, but first impressions are everything!) to self-awareness, an ability to listen as well as communicate, large ego indicators (managers whose career never benefited from luck, help and/or good colleagues) and small ego indicators (managers who encourage their subordinates to share in the presentation), manager interaction and interpersonal chemistry.

The conclusion is frequently framed by three questions.   One is “how much are you raising (now and in the future) and what is the use of proceeds?”  The second is “what valuation are you seeking?”   There is much to be said about these topics, but that will be for another blog.  The final question is “What do you see as the exit here?”  And that is a much trickier question that it appears.

This is one of those questions to which there are many wrong answers that can undermine a strong presentation but no right ones that will save a poor presentation.    As a result, it is also the question that entrepreneurs work hardest to figure out what we want to hear rather than what they want us to understand.   This may be because the question has a particular subtext that we should probably make explicit.  When we ask about exit, we are really trying to understand if we are aligned in our thinking.

Here are some of the issues we are thinking about when we ask the exit question:

  1.  Do the management’s aspirations match the company’s realistic potential?  It does not help to have a $500m CEO running a $100m opportunity, nor does it help to have a $25m CEO running a $200m opportunity.   In the former case, the company will be over-funded and over-built and returns will be crushed.  In the latter case, the company will under hire, both in talent and in numbers, and will jump at an early offer when the dance is just starting to get interesting.
  2. Is the fat part of the exit bell curve, as identified by the entrepreneur, sufficient to give us the return we need while making the entrepreneur wealthy?
  3. Are the exit scenarios well known or do they require novel mechanisms or new players?  For example, is the expected exit a trade sale into a sector with multiple active acquirers, who historically pay a fair price, or does the exit depend on the appearance of new and surprising players, like hedge fund migration into PE or China- or India-based acquirers?
  4. How does the idea of an IPO get framed?  The IPO as an exit remains deeply alluring, and almost completely remote, when one is raising first time institutional capital.  If the entrepreneur wants to put the idea of an IPO on the table, it should be with clear and realistic benchmarks of what the company needs to achieve to consider the public markets.
  5. Does the entrepreneur have a “personal number” that is consistent with the desired range of outcomes?

My suggestion is to aim for the fattest part of the fairway.  If I were the entrepreneur, I would tie exit valuations to the date of the sale, pointing out that if the company hits its revenues its value will be here in four years and there in six years.  I would use trade sale multiples as my benchmark, pointing out than an IPO or a competitive, high-multiple exit are possible and can and will be made as likely as possible, but are not worth deep consideration at this early stage.    I would say that I am in it for the money, and that means I would sell early only if the offer was exceptional relative to the company’s ongoing assessment of its risk.  I would ask the investor’s time horizon, and how many years the fund partnership has left, to be sure the investor can be patient.  Most of all, I would say that I expect to make money by building a great company and letting the exit take care of itself.

OVP Staff