Avoid These Mistakes When Planning an Exit

Among several key potential errors, the most costly may be trying to squeeze out every last dollar of valuation, a veteran technology CFO says.
Michael MorganJuly 15, 2016
Avoid These Mistakes When Planning an Exit

Technology unicorns are seeing their valuations crushed, and public tech companies aren’t faring much better. People are wondering whether we’re headed for a correction. But regardless whether this balloons into a full-blown downturn, the tech fundraising climate is undoubtedly changing.

Michael Morgan

Michael Morgan

Going forward, startups won’t enjoy the same access to deep-pocketed investors willing to wait and see if a business idea pans out. Companies are either racing to raise funds now or aiming to survive until the next fundraising boom.

Generally, privately held technology firms grow with a “liquidity event” in mind — usually an IPO or acquisition. Today’s market, however, is causing some companies to question their exit strategy. Historically, the optimal time to exit is rarely clear, with founders often facing uncertain conditions and insufficient information. But aptly timing the exit is even more complicated today, and founders should be wary of the most common mistakes made in planning an exit strategy.

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First, don’t look for an easy answer. There’s no “tried and true” way to exit. It all depends on the motivations of the management team. Some people want to change the world. Others enjoy the process of building and growing a business.

The question of timing is arguably the most important factor other than management motivations. The strongest companies don’t have to make a decision on that based on market conditions. I know it can be tempting to try and play the market, but that’s more often a sign of weakness than one of strength.

But the biggest mistake founders make when planning an exit strategy is focusing too heavily on maximizing the valuation. Plenty of companies did this in the most recent tech boom. It often doesn’t pay off, though.

A higher valuation usually means a messier term sheet (containing the conditions of your funding). This in turn limits your options as an acquisition candidate. Don’t try to capture every last dollar — if you do and the market turns, your early investors will be unhappy.

When I was CFO at Talarian Corp. in the late 1990s, we were approached by a competitor that wanted to buy us. At that time it was much easier for companies to go public, and dot-com boom was still under way. We were presented with a choice: go public or be acquired.

The acquisition offer was tempting. It came from a company whose stock was soaring past $200 a share, and the value of the stock we would’ve gotten was the equivalent of a billion-dollar offer.

We knew the market could change, though. We suspected our potential suitor’s stock wouldn’t remain at their offering price for the simple reason that their business foundation didn’t match up with the valuation. With that in mind, we decided to pursue an IPO instead.

When the bubble burst, our stock cratered like everyone else’s. But we had much less to lose, because we had never been inflated to the level that others were. Ultimately, our valuation was higher than the company that wanted to buy us.

A year or so after weathering the crash, our business was growing strongly and consistently. We ended up selling to Tibco and better serving our shareholders and employees by establishing a strong company and only taking an acquisition that would be beneficial in the long run.

We navigated the dot-com bubble and bust at Talarian by acting like a public company, even before we were one. Companies considering an exit should map benchmarks that public companies would. That way, if the IPO market heats up, you can be ready with the right infrastructure.

The alternative is watching a bubble burst, running out of cash, and going out of business if you haven’t built a war chest. Lots of companies are facing this prospect now.

The Present Challenge

So what do you do today, given the market conditions over the next year or so? It helps to know who your customers are.

All companies have three customers: the people buying their product or service, their current investors, and their future investors.

Future investors — public shareholders, for example — matter a lot. You have to please all three of these customers while building a company that’s attractive to future investors, as few companies can survive on product buzz alone.

Companies will still be able to raise funds during a correction, but the terms have changed. Capital is less available than it was even six months ago. Startups can’t afford to spend $3 for every dollar of revenue anymore. Companies with market fit and a path to profitability will get funded.

Other companies, even some that have had high valuations, will look for funding to put off an IPO. But even with down rounds, these so-called unicorpses will survive. We’re not dealing with the end of times — just a cold slap of water.

Above all, never lose sight of your customers — and not just the ones buying your product. That will help you avoid the most common missteps of planning an exit strategy, be it looking for an easy answer or being fooled by the market. Optimizing for current and future investors will give you the most flexibility to exit on your terms — the one true sign of a great exit.

Michael Morgan is CFO of Tegile Systems, a privately held enterprise storage vendor. He has more than 25 years of experience in managing all aspects of finance and administration for private and publicly held technology companies, building companies from startup through IPO, and leading M&A transactions on both the buy and sell sides.