In tech entrepreneurship, the traditional route of building a company, achieving profitability, and waiting for the right buyer is becoming outdated. The evolution of the tech exits process is reshaping the landscape, emphasizing proactivity, strategy and early planning.
1. You May Not Know that Your Tech Company is Ready to Exit
Old School Thinking:
In the past, tech companies aimed for profitability, hoping the right buyer would come along at the right time. This passive approach often led to missed opportunities, undervalued sales, and companies pursuing exits during periods of declining growth.
Modern Thinking:
Companies have learned that they can sell for more money if they are actively sold rather than passively bought at the leisure of an acquirer. A successful exit requires a strategy, preparation and execution. Selling a tech company is almost always more successful with a strategy, structured process, and the tenacity of a professional M&A advisor. This is particularly true for early-stage tech companies.
Companies Don’t Need to Be Big and Profitable to Be Sold:
My advisory, Exits Partners, has researched over 1,500 companies and 5,000 transactions. Almost half of all exits are for companies with less than $10 million in revenue, which directly contradicts old-school thinking that companies have to be big and profitable to exit.
Characteristics of Early-Stage Tech Companies Ready to Exit:
Research indicates that early-stage tech companies can achieve successful exits if they possess one or more of the following characteristics:
- Profitable and Rapid Growth
- Specialized SaaS Companies Meeting Key Metrics
- The Four Pillars of Early-Stage Success:
- Intellectual Property
- Core Competencies
- Third-Party Validation
- Market Traction
- Well-Prepared Documentation
2. When Should Your Tech Company Exit?
Identifying specific points in a tech company’s evolution when it may be an optimal time for exit is crucial. Key points include:
Series A Inflection Point: When a company begins to scale and becomes increasingly complicated to manage, it may need an infusion of a Series A round of venture capital to fund the growth. At this point, many founders might decide to seek an early exit rather than take on the stress of scaling, and the dilution and governance that comes with venture financing. The decision is key to the company’s future.
Exit at a Proof Point: Value in a tech company is not created linearly, particularly with early-stage tech companies. The valuation jumps significantly when the company achieves an important milestone. Significant milestones such as repeat customer purchases, strategic partnerships, or market dominance can trigger a successful exit.
Exit Timing: Companies often grow following an “S-curve,” slow in the beginning, followed by rapid growth when the company’s products are purchased in scale by the mainstream market, and succeeded by a tapering once the market is satisfied. Consider the company’s life cycle, industry dynamics and market trends. Exiting during the rapid growth phase is ideal.
SaaS Companies: For SaaS companies, meeting specific key performance indicators (KPIs) can indicate readiness for an exit:
- Growth Rate (50% – 100%)
- LTV/CAC Ratio (>3)
- Customer Churn (<7% per annum)
- Payback (<12 months)
Four Pillars:
- Intellectual Property (IP): A suite of patents that protect a technology will be valuable to the acquirer. The value of patents lies not just in having them, but in their broadness and strength, making the protected market attractive and resilient to challenges.
- Core Competencies: A company with a top-tier research team may be acquired for its expertise, irrespective of its business state, with validation coming from industry players rather than numerical proof.
- Third-Party Validation: Companies with validated prototypes or sales to early adopters, especially in fields like robotics, can be attractive to acquirers based on external validation.
- Market Traction: Companies showing dominance in industry KPIs, such as mind share, user count, or significant sales in a specific market, are of interest to acquirers, emphasizing demonstrated capability over commercial success.
3. How to Prepare Your Tech Company Exit
A fully marketed tech company exit takes between six and 18 months. The better the company is prepared, the less time the process will take. Key steps include:
Develop an Exit Strategy: The exit strategy should be formulated at the founding of the company. Then, all subsequent decisions and actions can support the exit strategy instead of impeding it. A key element of the strategy is whether to exit early or to scale the company for a big win. This decision informs other key decisions.
- Early Exit: With an exit early, the only capital it should raise should be from family, friends, and angels. This allows the timing of the exit to remain with the founders. If the company raises a VC round, then the VCs will have reserve rights that allow them to control the exit, which may impede the Founders’ exit strategy. A company pursuing an early exit strategy needs to develop a set of milestones or proof points, the achievement of which may be sufficient to interest an acquirer.
- “Go Big”: If the company chooses to go for the big win, then it is also deciding to exit by a public offering, or, more likely, by a buyer looking not just for a strategic fit, but also one which is accretive to revenues and earnings. The company can expect several rounds of financing to achieve its goals. Importantly, because the company will likely have venture capital investment, the minimum acceptable exit valuation will be set by the VC’s expectations, which could be up to 10 times the valuation at the last financing round … a large amount. As the company grows, management and governance will become more formal. These decisions and outcomes have a profound impact on the company’s strategy and operations. This is why the exit strategy must be considered early before the first round of financing is raised.
Build Alignment: Build alignment among all stakeholders. If any have reservations, disagreements could surface and could destroy the exit. The alignment should be tested as each stakeholder’s exit milestone is achieved, and no less frequently than annually.
Choose M&A Advisors: It’s never too early to engage with M&A advisors. Be sure to choose one based on your exit strategy. Their job includes negotiating price and terms to best suit the seller, assisting the company in all aspects of preparation, and expediting the process when necessary.
Involve the Board: Leverage the expertise of the board of directors throughout the exit process.
Virtual Data Room: A key determinant of how long the exit takes and its success, is the virtual data room (VDR). The VDR organizes and stores all important data and confidential documents, streamlining due diligence.
Financial Model: Develop a comprehensive financial model to impress potential acquirers.
Sales Collateral: With the help of an advisor, create and capture your value propositions in your confidential information presentation and executive summary.
4. Exits Execution
With preparations in place, the exit execution involves a series of steps:
Marketing the Company: Based on the value proposition, M&A Advisors may identify 50-250 companies, contact 100 or more, respond to 10-50, deliver the CIP to a dozen or so, and start due diligence with 5- 8 to get to an ideal shortlist of three. This marketing process requires intensive work over several months.
Engage M&A Counsel: The company needs counsel that has significant experience in M&A, so allow them to quickly review, comment, and edit the formal legal purchase documents and properly advise the company on the terms. Counsel should be involved in all of the remaining steps.
Negotiation: M&A Advisors leverage the interest of the best prospects to develop the optimum exit transaction. Ideally, they would attempt to negotiate offers from three final contenders based on formal Letters of Intent. This negotiation may take a few months.
Select Top Contender: The M&A Advisors and M&A counsel will discuss the optimal offer with the founders and directors, who will decide whether to approve the exit transaction to proceed.
Sign the Letter of Intent: Once the Letter of Intent is signed, the transaction moves into the Closing phase.
Exclusivity: The chosen acquirer normally has a period of exclusivity of 30-90 days in which to complete due diligence and draft the formal purchase documents. The company cannot communicate directly or indirectly with any other bidder during the exclusivity period. The company should negotiate hard to shorten the exclusivity period to 45 days or less to reduce the chance that something unanticipated disrupts the process. As the saying goes, “Nothing good happens to the seller after the Letter of Intent is signed.”
Non-Disclosure Agreements (NDAs): Ensure confidentiality with NDAs during the due diligence process.
Due Diligence: The acquirer will review every important document the company has on file. The better the documentation is organized, the easier the process is. M&A Advisors usually manage due diligence to reduce stress.
Formal Purchase Agreement: Prepare and negotiate the formal purchase agreement. The most important part for the seller is the lengthy set of representations, warranties, and covenants that the sellers are guaranteeing to be true. The buyer will always hold back 10-15% of the purchase price as insurance against any defect in the representations. The buyer’s M&A counsel also prepares many of the appendices attached to the purchase agreement documenting important facts about the company.
Closing: When all the documents are prepared and due diligence has been completed, the transaction is ready to close.
In Conclusion
Mastering the tech exits process requires foresight, strategic planning, and collaboration with seasoned advisors. By embracing modern thinking and adopting proactive measures, your tech company can position itself for a successful and lucrative exit.
