Bill Payne has been enabling entrepreneurs through Angel Investing since before it was cool.

Six Days to Success - Securing Angel Capital - Day 5

Entrepreneurs are often quite surprised when asked early-on to define the company’s exit strategy. In fact, this is a most logical question.  It is critical that the interests of entrepreneurs and their investors be carefully aligned. The culmination of the investment process is the harvest, that is, exiting the business with an attractive return on investment for both the entrepreneur and investors.

Investors are not banks, to be paid back with interest after a pre-arranged period of time or upon the achievement of specific milestones.  Neither do investors fund “lifestyle” businesses, those ventures designed to provide substantial income to the entrepreneur but only modest growth in the valuation of the company.  Angel investors and venture capitalists seek substantial return on investment in a relatively short period of time, say 5-7 years.  What is substantial?  Funding startup companies is high risk investing, with most of the return on investment resulting from 10 to 25% of portfolio companies. (That’s right. . . the other 75 to 90% do not survive or provide investors with some return of capital or a small return on investment, only covering the investment in those companies lost.)  For these reasons, investors in startup companies seek 10 to 30 times their invested capital in 5-7 years.  With these returns for a small fraction of their invested companies, angels seek portfolio returns of 20-25% per year.

When defining their exit strategy, investors are asking the entrepreneur to take off his or her founder/CEO/employee hat and exchange it for the shareholder chapeau.   Yes, entrepreneurs serve these two roles in their companies and the two functions sometime conflict with one another.  By describing their exit strategies, investors are asking the entrepreneur to view the company solely from the perspective of the shareholders.  Alignment of objectives is a critical ingredient in the relationship between investors and entrepreneurs.  How can the entrepreneur and investors optimize the return on investment for all shareholders?

What are the exit opportunities for entrepreneurs and their investors?  Traditionally there have been two:  an Initial Public Offering (IPO) in which the company raises money from public markets, which eventually (over a period of years) allows private shareholders to sell their shares in public markets.  The second alternative is selling the startup company to a larger private company for cash or to a public company for cash or publicly tradable shares of the purchaser.  It is important to note that selling to another private company is really not an exit, only a trade for illiquid shares in another venture.

In the past decade, public markets have not embraced many new security offerings from private companies; consequently, selling private companies via a merger or acquisition (M&A transaction) has become the primary exit opportunity for investors and startup entrepreneurs.  Angel investors are more that ten times more likely to exit their early stage investments via M&A transactions than IPOs. 

A common mistake made by entrepreneurs in defining their exit strategy is to summarily state their exit will be by an IPO or via an M&A transaction.  This is totally insufficient.  Investors want to confirm that an M&A exit after successful execution of the business plan would in fact be attractive to potential buyers.  It is incumbent upon entrepreneurs and their advisors to think through possible exits.  What strategic buyers would pay an attractive price for a successful company in this space and why?  What exit alternatives are likely to be available to the startup company in 5-7 years?  Entrepreneurs need to be quite specific in defining possible exits. Or else, there will be no entrance!

Tomorrow’s installment is called:

 “BRINGING HOME THE BACON – Closing an Angel Round! "

Sincerely,

Bill Payne

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Raising Money from Angels” Now

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