Crafting the Exit Plan that Helps Startup Investors Say “Yes”
A compelling exit strategy could be the pivotal key to getting the money you need to fund your startup. Showing investors that you’ve thought through this critical step increases their confidence and boosts your odds of getting funded.
Join Denver-based angel investor Todd McWhirter, who has analyzed more than 300 startups and raised more than $13 million for both his and others’ ideas over the last 18 years. He’ll show you why your exit strategy is important, walk you through the major types of exit strategies and reveal how you can make yours attractive to investors.
Nate Warren is the host of the Business Planning Expert series and a marketing/advertising/PR writer and editor with more than 25 years of experience across newspapers, startups and agencies. Nate interfaces with internal and client strategists to crystallize B2B or B2C messaging for any medium.
Todd McWhirter has been an investor in startups for 18 years. During this time he has analyzed more than 300 startups, raising more than $13 million for both his and others’ ideas. This adventure has brought him both devastating failure and wild success.
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Nate: Hello and welcome to The Center for Business Modeling’s Expert Series podcast. The Center for Business Modeling’s mission is to help business leaders and entrepreneurs plot a simplified path to success with a full array of streamlined financial, operations, sales and marketing planning tools.
Our guest today, and by the way, I’m your host Nate Warren, is Todd McWhirter, and in the interest of making the best of your time today, Todd is going to give you about 15 minutes of solid insights so you can get on with your day and focus on what you do best. Hey Todd, good morning!
Todd: Good morning Nate! Thank you for having me.
Nate: Absolutely. It is our pleasure that you joined us. So in short, for those of us who were just joining in…If you are trying to launch a startup that is going to require investor dollars, this talk’s for you.
For you, Todd has been interested in startups for more than 18 years and during that time he has analyzed more than 300 startups and raised more than $13 million for both his and others’ ideas. This adventure has brought in both devastating failure and wild success. And Todd, as I understand it, today you are going to talk about how important crafting a good exit strategy is when you’re planning a startup.
Todd: Yeah, and in particular when you’re planning on raising money.
Nate: Absolutely. So that being the case, I’m going to get out of your way and give you the podium.
Todd: Well, thank you, Nate, for the kind introduction.
Nate: You bet.
Todd: So if you’re listening to this podcast, chances are you are an entrepreneur who is trying to raise some money to launch or scale your business or maybe you are planning on raising the money in the future. So I first want to say with all sincerity, it takes great courage to be an entrepreneur and I commend you. Entrepreneurs like you are making this world better; you’re solving problems, you are filling needs, you’re creating jobs. Truly, hats off to all of you entrepreneurs.
So my goal really is to give you a few tips as an investor myself, give you a few insights into the mind of the investor when it comes to the exit strategy to help you raise the money you need. Like Nate said, I have analyzed well over 300 startups and have invested in 26. Why did I say “Yes” to the 26? More importantly, maybe, is why did I say “no” to over 274 ideas?
Most entrepreneurs think we say “no” because the idea wasn’t good enough. Of course the idea is important, but at least for this investor, and I suspect most, the majority of investors, your exit strategy, as far as importance, trumps the idea. Let me explain.
Using the analogy of a front door and a back door to help you understand the importance of your exit strategy; we investors enter your business with your offering – the front door. We make our money via the exit – the back door. If you only remember one thing from this podcast, I hope it is this. If investors don’t understand and believe they will get out of the back door, they will never, ever enter the front door. In other words, a big reason I said “no” to over 274 proposals was because they had a weak exit strategy. I did not believe or did not quite understand how I was going to get my money back out. I thought I might just get stuck in the house, therefore I said “no” to the opportunity.
So what makes an exit strategy appealing? Three words – exciting, and what I mean by “exciting” is an extraordinary return of investment. Detailed, and thirdly is it has to be based on reality. If your exit strategy is lacking in any of the areas, raising money will most likely be a frustrating experience. Think about it – investors know the risks are high. They know that many of their startups investments will fail, so they are naturally looking for something very exciting if the company succeeds. Certainly they care about the idea but the idea is you have a detailed plan and certain of your babies, your idea, will become great. This is obviously important.
The investors’ baby, however, is the cash we are investing, and we need to see those details that funding that cash surrounding the idea. How will our cash grow and how and when will multiple of that cash come back to our wallets? We are looking for details in that area.
And finally, reality has to be a part of the equation – an exciting detailed exit strategy that is pie-in-the-sky will not help your money raising efforts.
Let me briefly share the four basic exit strategies while focusing on the need for the exit to be exciting, detailed and based in reality.
These four exit strategies:
2. Selling the Company
3. Buying Back Shares
4. Going public
are really the only way we investors can get our money back. That’s it.
If none of these exits happen, we are stuck in the house; our money, our baby does not experience any real growth. Even if your company is growing its revenue with no exit, there is only paper wealth, and believe me, paper wealth that is not liquid — with no clear liquidity in the future — is not exciting for us investors.
No, I hope it makes sense that we investors are going to be looking very closely at your exit plan. We’re going to be asking ourselves – is this exit plan exciting enough for the risk? How much detail has the entrepreneur given the exit? Have they given the exit as much detailed thought to selling the product? And how realistic is this exit?
So let’s take each exit and let me again drive home the importance of making sure your exit is exciting, detailed and based in reality. Have I said those three words enough yet?
Nate: Yeah, I’m starting to feel them getting tattooed to my forehead.
Todd: They are important. So let’s just take one other time. Let’s take dividends.
A couple of positives on this exit; some investors are looking for cash flow. So it directly appeals to those investors. Another positive is that because it is paying dividends, it is clearly focused on profit. Being profitable allows for all other exit possibilities down the road. If you are a dividend-paying company, for example, your ability to attract a buyer to your business has increased greatly.
So now let’s bring those three “musts”; exciting, detailed, realistic. Let’s bring those into this particular dividend exit strategy. If your exit plan is dividends, then you better have the financial projections that show detailed expenses and realistic revenue levels.
Quick story: I was with an entrepreneur and it was a dividend exit and I was looking at their pro forma and I pointed out a few expenses that the entrepreneur had not thought about. He had sort of lumped the expenses in big broad categories and so I brought up two detailed expense potentials. He said this: “This is my first stab at expenses.” Wow! I didn’t invest. It was clear to me that he had not put enough detailed attention into his expenses and was trying to raise money with quote unquote his “first stab” at expenses.
So let’s take the “exciting” word. A dividend has to be exciting – extraordinary return on our money. Now, for example, if it takes more than five years for us to recoup our initial investment via dividends if this is your exit, it is probably not exciting enough. Why? Because of the risk that we are taking, we know many of our startups are going to fail.
Okay, so let’s say you have an exciting dividend goal, give detailed expenses and you have realistic projections. Is this enough? Well, there is one very important piece of the puzzle that investors need to see. I call it the Same-Page Philosophy.
Same-Page Philosophy is this; we investors want you entrepreneurs to get crazy wealthy, as much as you do. However, we want you to get wealthy the same way we do – as shareholders, not as employees earning huge salaries or taking huge bonuses. We want you to need and want the exit to happen as bad as we do. There are many things you can do to create the Same-Page Philosophy with us investors, but for this talk that may just explain why.
If your exit is dividend and you own the most shares out of any shareholders, wouldn’t it put you on the same page with us; one thing almost needing dividends if you put yourself on a salary cap? Talk about bringing realism to your exit plan. It’s just a great way to put you on the same page with us investors.
So let’s take the selling the company as your exit.
Selling the Company
This is probably the most common exit I see. This exit appeals to the largest segment of investors. Investors love to see their money grow and then get cashed out. Let me bring you another story through bringing in those three “musts.”
I remember very clearly an entrepreneur telling me their exit was to sell the company in 3 to 5 years for a large multiple; sounds great, right? So naturally, I asked questions about his plan: “Who do you think might acquire you?” His answer: “Lots of companies would love to gobble up a company like ours.” I asked, “Who in specific?” He drew out some big names. I asked, “Have you any research on what acquisition have been made by these companies recently?” His answer: “No, we’ve not really started that research yet.” Needless to say, I did not invest – no details, no realism and definitely not exciting.
If this is your exit of choice, to sell the company, don’t forget to bring in those three “musts.” Make sure your pro forma has detailed expenses, revenue and profit projections. Make sure you researched recent comparable acquisitions – almost every industry has examples of bigger companies buying smaller companies. Showing us investors examples will give us confidence that there is reality to your goal of selling the company the goal price. I want this to be realistic, but exciting.
So, for example, if we are buying in at, say, $1 million valuation and the sales price projections for your company are around $5 million, you might have a problem. A 5X return considering the normal startup risk probably won’t bring many “yes” investors.
And finally, brag on your team and your board. Selling your company for a huge multiple is no easy task. We investors are looking at your team and asking ourselves if this team has the capability to succeed at the task of selling the company down the road. We are looking for a track record. We put more weight on the team or the ability to build the team than we do the idea. Show us you have the team that executes and your exit becomes much more realistic.
Buying the Shares Back
So let’s take the “buying the shares back” exit. I am not going to spend much time on this exit because I don’t think this exit will bring you many “yeses.” It works for niche investment like a real estate deal where there is no bank involved, therefore all the money invested has collateral on a building. There is limited risk in that scenario to the investors, and so buying shares back can work in that niche. But in the normal startup investments, it just doesn’t make a lot of sense.
You usually can’t project a realistic buyback on a multiple that make sense to investors considering the risk. Questions arise: Where are you going to get the money to buy us out? And then – what are you buying us out? There is a natural conflict of interest that arises. Usually companies buy shares back when they know the price is right, i.e. cheap, and they are confident the company will be worth way more in the future.
So let’s move on to the final exit strategy – taking the company public, or what is called an initial public offering, IPO.
The easiest way for me to cover this is to list a few pros and cons – the pros.
It is extremely prestigious in that awareness that your company gets is amazing. And it really is potentially a massive ROI – think of the recent Twitter that went IPO, they are worth over $20 billion now, so it can be very exciting. When you are that public, there is so much awareness around your company, you can attract top talent, partners, lots of cash is coming in and you can use that cash for acquisitions or scaling your company. Lots of pros.
The cons – this is not for first-time entrepreneurs. It is extremely difficult to take a company public through an IPO. The stock performance risks – the first investors typically have to wait after the company goes public, they have to wait a year before we can sell our shares.
Many things can happen in that year; things can go up, down based on things out of your control. You surrender a lot of control when you are raising millions and millions and millions of dollars through taking a company public, you surrender control, there is lots of dilution and there is a high level of scrutiny, lots of regulations that need to be followed through this exit strategy.
Let’s take bring in the three “musts.” Is this exciting? Yeah, it’s pretty exciting – usually. Is it detailed; is it based in realism? “Detailed and based in realism,” that’s the tough part. I rarely see a detailed realistic strategy to go public. I’ve had plenty of entrepreneurs tell me this is their exit and when I asked their plan, they have said things like, “Once we are at X revenue, we will engage with the right investment bank who will help us do that.” Pretty vague.
Taking the Company Public
Taking a company public is not for the first-time entrepreneur. Most investors will not be convinced of this exit strategy unless you have a proven team or a board of directors who have done this before. Even then they will want a detailed plan showing your steps toward the successful IPO.
I don’t want to sound negative on this strategy as it is very exciting, but it is the most difficult exit by far and if you’re using this as your exit, you must be prepared for investors to scrutinize your ability to succeed.
So thank you for your time. I appreciate it, good luck raising money and I appreciate you, Nate, letting me give my few two cents, give my two cents out there.
Nate: If our listeners out there are serious about succeeding, I imagine they would appreciate your time, as well. Hey Todd, before we jump off, do you have time for a question or two?
Nate: Just so we have got you on the line, can you tell me about other kinds of… What else about an exit strategy really tends to grab your attention and make you more likely to reach for the checkbook?
Todd: Yeah, that’s a great question actually. There is a few that I would call “cherry on top” things you can do. Couple of them I will cover real quick: One would be offer a warrant. These are basically stock options for the first investors. The more appealing the warrants, the more likely they will help turn “maybes” into “yeses.”
For example, you could offer something like: if you put 25,000, if you invest 25,000 then you will have an option for another 25,000 at, say, a 50% discount from a future round of money raising. There are many ways to set these up, this is just one example and by the way, any of the listeners can feel free to connect with me on LinkedIn if they want more information or want to discuss any of this information.
Nate: Absolutely, in fact your link is right up there right in our site, sorry to interrupt. Go ahead.
Todd: Oh no, that’s right. There is another sweetener that I would like to share that does bring out the checkbooks and that is one of my favorites: It is sometimes called the preferred return. This is where you set up the deal until they get whole.
For example I will share with your recent investment that I actually just invested in. I won’t give the name and details but basically the investors, we investors, the money deal and 50%. It was a dividend play.
The way they set it up is that they set it up where we would actually own 75% of the deal and our dividends would be coming at that level until we got money back. Once we got money back we would go back to the 50%. So there was an accelerated of our money coming back to our wallets and once we got whole, it went back to 50-50. It was a really unique sweetener that the entrepreneurs put together for us investors and no doubt it helped the checkbooks come out for sure.
Nate: Yeah, it sounds like there are all kinds of creative ways to structure these things. You really listen to your investors and understand where their levers are.
Todd: No doubt. Understanding the mind of the investor is really key to raising money ,I believe.
Nate: And one other if you’ve got the time. In your experience, does a good exit strategy serve as a self-fulfilling prophecy? Or to put it another way, have you noticed that having a good end in mind gets entrepreneurs more focused on creating that outcome?
Todd: Oh, absolutely! I mean starting with the end in mind does increase focus. I have often said a goal without a plan is no more than a wish. So in this context, the exit goal without an exit plan is only an exit wish. So having an exciting, detailed, realistic exit plan, no doubt will make everyone more money, including the entrepreneur.
Nate: Perfect. Yeah, Todd we really appreciate you taking the time for our listeners today.
Todd: Well, absolutely, it’s been my pleasure, and again, if anyone wants to reach out on LinkedIn, feel free. And thank you Nate for having me.
Nate: Absolutely, those of you who are watching along will see we’ve got Todd’s LinkedIn; linked his profile right up there on the site, so please feel free to reach out to him, unless, of course, you haven’t done any work on your exit strategy; in that case, do some of that then get a hold of him.
That’s it for this installment of The Center for Business Modeling’s Expert Series podcast. As always, we are here to help you take the brain damage out of business planning. So feel free to head on over to Centerforbusinessmodeling.com and avail yourself of the many resources we have on the site right now. So until next time, this is your host, Nate Warren. Thank you for listening once again.
I look forward to seeing you again with more great guests and their business planning insight. Good day, success to all and keep planning to win.