Preparing For An Exit

In my last article I shared the journey we embarked on when selling Sucuri.

In this article I will share insights I have collected over the past decade working with all types of organization. These are just a few of the things I wish I knew before, and things I believe will help improve your business hygiene in anticipation of an exit.

This article is comprised of observations, insights, opinions and not designed to be reflective of how any one entity does business. It should not be used to reverse engineer insights for any one organization as its cumulative insight from over two dozen corporations, public and private, and biased to my limited insights and engagements.

Do You Have Something Worth Buying?

Before thinking about an exit, you need to ask yourself one very important question – do I have something worth buying?

At some point, most folks will want to some form of liquidity event, but not everyone will be able to. Wanting to exit, and being able to, are two very different things.

Have you validated that there is a need for your solution? Is it really solving a problem? Or is it a problem in your own mind? Do you see, can you quantify, the demand for this solution? Can you articulate the problem space?

If the answer is yes, then proceed. If the answer is no, start there first. You need a company to solve a problem.

Improving Your Business Hygiene

A friend recently sent me the following message:

I know I want to sell, but not sure what I should be focusing on. Any thoughts?”

Friend

Having this level of conviction is great, and I envy him for it because it tells you what you need to do.

Below is a cleaned up version of what I shared with him. It specifically highlights a number of things he should do to institutionalize his business and help get his business hygiene in order.

1 – Get your Financials in Order

The product gets you in the door, your financials determine your worth (i.e., value).

Establishing value is an art, not science. Few of us will ever see the ridiculous valuations you see with Facebook and Google. The reality is, we don’t have that kind of value to any organization, or impact on the world. Most organizations will take a very pragmatic approach to calculating value.

I have a friend who remembers the day that Google called them and said, “Hey, we want to pay you $700M + for your product.” They were only making $30M ARR. I don’t want to burst your bubble, but statistically speaking, the odds are not in your favor you’ll have this kind of exit.

Whether it’s a finance, or strategic, partner your value will most likely be calculated from your financials. Shortly after our acquisition, I wrote a brief post on financials that I’ll expand on in the future.

If you are a product company selling to a product company, then your product will get you the executive sponsorship you’re looking for. Depending on the size of the buyer, the one calculating your value could be someone very different than your executive sponsor.

In short, make sure you get your books in order. Not all CPA’s are created equal, make sure they understand your industry, and business.

2 – Type of Buyer Will Dictate Activities

There is a difference between a strategic and financial buyer.

A strategic buyer might be someone like a Google, Facebook, Microsoft, etc.. While a financial buyer might be a Private Equity (PE) company. Each one will bring with it a very different perspective and demand a very different focus area. This is not hard fast rule, some of these companies can also be financial institutions. You can also replace these big names with names in your respective industry.

Strategic Buyers

Strategic buyers are going to be interested more in the product efficacy, integration, team size, audience overlap, ability to scale, and team. You can expect deep dives into each of these. You’ll want to have the appropriate artifacts available. As frustrating, and potentially invasive as this might feel, the more you have readily available the better it will be.

Example of artifacts you’ll want to have readily available for a strategic buyer:

• What does your architecture look like?
• How does data flow through your system?
• How do you scale?
• How do you handle privacy? security?
• What does your CI/CD process look like?

These should not be confused with having a good business, but having these artifacts will provide someone that doesn’t have the time or level of insight to your business to quickly check a list in their own mind of what good looks like.

This is not to say financial buyers aren’t going to ask the same questions.

Financial Buyers

Financial buyers are going to be focused on financial performance and their ability to get a return on investment (ROI). They do care about the product, and market, that is what is going to tell them how much opportunity exists.

Example of questions a financial buyer will want to understand:

• What is the total addressable market (TAM)?
• What is your Average Revenue Per Unit (ARPU)?
• What is your growth vs your churn?

While you always want to know your unit economics, regardless of buyer type, they will carry different weight based on who the buyer is. I would wager that if your economics are not contributing materially to the strategic buyer, then insights into your unit economics are more theater than practically important. They will be used in calculating value in both instances.

Buyer Type Matters

If you’re selling to a large corporation and you’re a startup, your revenue is likely to be a rounding error in the grand scheme of things. With strategic purchases, win the technical teams and they’ll be your biggest internal advocates. If your are materially impactful to the company, then the opposite might be true.

With financial purchases, while they care about the same things they will likely not have the technical teams to make sense of what you’re doing and if what you have in place will work. But seeing the artifact will check the box they need to feel good. Their real focus however is – Can I yield X% return in Y number of years? That’s the answer they are looking to answer.

Regardless of the type of buyer, be prepared to help them connect the dots. Work to map out potential suitors, and start finding ways to cross paths.

3 – Create Self-Sustaining Teams

If you know you want to exit, you are lucky. I would encourage you to spend some time focusing on creating self-sustaining teams. They should be able to truly own the product and business vision and direction. This will give you what you need to seamlessly transition your company to a new owner, turn-key.

This will reduce the amount of time you have to spend with the buyer post-acquisition. It also helps show the buyer a level of maturity they require to help reduce their potential exposure. The big thing you want to be sensitive about is a “hub and spoke” configuration where you are at the center of it. This can cause a lot of anxiety to a buyer.

A hub and spoke configuration can spook both financial and strategic buyers. Is this all built around this one person? or team? Will it all fall apart if they leave when they cash out?

You owe it to yourself, and your team, to make the appropriate investments if you know you want to exit. Showing this level of investment will pay dividends, it will show a level of institutionalization that demands value.

4 – Raising Capital

To raise or not to raise. Perhaps one of the most common questions I get. Unfortunately, it’s not a simple answer, but if you know you want to exit I would encourage it.

Raising capital provides legitimacy to your organization, and sets a value. Once an investor sets a value, if you continue to perform well, it’s hard for a buyer to legitimately explain why the new value is less. It also helps set a baseline from which to work from.

It’s one of the reasons why buyers will always try to understand if you’ve done any financial rounds. It’s definitely something you can share, but not something you need to initially. You can say how much you raised, but don’t necessarily have to share the exact value. Providing the exact value sets a baseline that can be used to negotiate and justify a position.

The good things about raising capital is that you have a team that is motivated to get a return. They can help you strategize, and they can also help you find suitors – both strategic and financial. This is what they do every day; when you know you want an exit, why would you not engage someone that does this every day?

You can own 100% of a small pie or a smaller percentage of a much bigger pie. Again, this is only applicable if you know in your heart of hearts that you will exit.

Set yourself up for success.

5 – Be Ready for Taxation

I could go on and on about taxation, but understand there is a difference between a stock and asset purchase. An oversimplified explanation: One is more favorable to the buyer, the other to the seller. There are reasons for both, based on your industry, and type of business.

If you know you want to exit, then you want to be cognizant of any potential tax benefits, or pitfalls, you might encounter. You don’t want to become aware of this at the 11th hour.

Make sure your corporate structure isn’t going to complicate a transaction – for your buyer, you the seller, or you the individual. You also want to be intimately familiar with your specific jurisdiction (e.g., state, country, etc…) and their specific taxation rules. For instance, in the US if you are a C corporation you have the ability to qualify for Qualified Small Business Company (QSBC) which provides specific tax exclusions if you qualify (note, there is a a time period you have to be cognizant of).

Get yourself a good tax attorney, one that is familiar with these kind of transactions.

6 – Take Care of Your People

Your people are the foundation from which you build on, and will deem your product / service successful. Always remember to take care of them first. Your “people” is all encompassing, your customers, stakeholders, and employees. They must all come before yourself.

Customers

Make sure you have the appropriate conditions to protect their sensitive information. There should be a plan for how the change of hands will be communicated, and what the specific impacts might be.

Stakeholders

Make sure you have the appropriate covenants to accelerate their vested values in the event of a transaction.

Employees

Set aside an option pool at inception with acceleration. Do this early when the par value is extremely low. Trying to set this up after an investment round can be tough, and almost impossible during an exit.

If you know your intentions are to exit, be sure every one knows.

7 – Be Cognizant of General & Administration & Overhead Costs

It’s difficult not to think you’re behind the power curve when it comes to G&A overhead. But I would wager, more processes is likely not what you need more of when you have a startup.

I have yet to see an acquisition be defined by – They just had this one amazing HR person! Their Accounting team was the best I have ever seen, had to buy them!

This isn’t meant to dismiss their value to an organization. They bring tremendous value, they just aren’t what determine your value in an exit. They are also the first to potentially go depending on your acquisition.

I would focus on those things that have real impact -> sales, marketing, product, engineers. These days, you can outsource a lot of G&A activities for a fraction of what it costs to have in-house teams.

In the not so distant past, being 100% remote was not always an accepted business structure. Doing so would often be frowned upon, and could contribute to a discount in your value. With the current state of affairs, I would not be surprised to see a shift in this thinking as more large corporations recognize the benefit of remote work (e.g., ability to attract talent globally, reduced overhead from not needed infrastructure).

If you want to exit, find the right balance between what you need and what you don’t. Leverage third-parties where you can. This will pay dividends at the point of your exit.

You Can Do Anything, Just Not Everything

If you have the fortitude to know that you will exit, I envy you. Just remember you can do anything, just not everything. Be thoughtful in the actions you take, you’ve already overcome the hardest piece – knowing what you want to do. This level of insight affords you an opportunity to ensure you get your foundation right.

Even if you don’t have this level of conviction, then understanding the above should be something that you can plan for and shelf in the event it ever arrives. You don’t have to do them all at the same time, but many can be done in parallel. Some are basic conversations to educate yourself, while others will require a bit more work to implement the appropriate processes and controls.

These are just a few of the things I have picked up over the past decade around ways to get you business hygiene in order. In the future I’ll spend some time sharing some tips on how to your technical hygiene in order.

Now, grab those reigns and enjoy the ride!