exit-s
Business Management

Steve Goodman (US) - When Less is More: Developing a Short-Term Exit Strategy

To exit or not to exit? That is the question. However it's not one that most founders of early-stage companies take time to consider when they begin building a new business. Whether it's the hope that their start-up gamble will become the next Facebook or Zynga, or the urging of VCs to take a longer-term view, entrepreneurs rarely start out with an exit strategy in mind.

But maybe they should. If entrepreneurs build their businesses with the intention of selling it within the first 18 to 24 months, they are able to strike a fine balance between risk and reward for their investors and themselves. While the return may be less than what appeals to institutional investors, this strategy offers much more in terms of quicker ROI and minimized risk. In fact, technology start-ups in the U.S. are showing that there are benefits to this unconventional approach that should not be overlooked.

Why Longer Isn't Always Better

When working with technology entrepreneurs, most VCs take a conventional approach, advocating a five-year investment horizon that enables the company to build marketshare and a sizeable customer base in order to make it ripe for a high-value liquidity event. This conventional approach is evident when looking at a recent Dow Jones VentureSource report that shows the average age of acquired companies was just over five years in 2010.

The problem with this longer-term investment strategy is that, for most companies, getting a sizeable return is a rare occurrence. During the last three quarters, only 15% of all deals achieved a greater than 10x return, according to recent statistics published by Thomson Reuters and the National Venture Capital Association. The majority of deals were in the mid-range, with 29% achieving 4x to 10x returns, and 36% in the 1x to 4x range.

Company founders may miss a critical window of opportunity if they take the long-term view advocated by many VCs. Trends show that often after two years, a start-up's valuation begins to decrease as the risks associated with maintaining and managing growth starts to skyrocket. This is particularly true in the U.S. technology market, where the rapid pace of innovation results in a very short period of time during which start-ups offer strategic value to potential buyers.

By planning an exit within the 18- to 24-month timeframe - when valuation is the highest and risk is relatively small - you can propel your product to market in a way that may not have been possible as a stand-alone company and achieve a solid return for yourself and your investors in a relatively short time.

Planning the Two-Year Exit


To achieve a successful exit in 18 to 24 months, you need to build your company a bit differently. And it's requires more than just identifying a trend and creating an innovative, differentiated product that could be an attractive acquisition target.

First there's the structure of the company. What's most important - beyond having great engineering and sales teams - is being able to quickly build buzz with potential buyers. This entails strategic business development activities aimed at targeted acquirers and key executives within the appropriate business unit at those companies, as well as early public relations efforts to position build market awareness of your company and its disruptive technology.

The second step requires finding the right type of investors. This short-term exit strategy is well suited for angel investors and smaller, progressive VCs, for whom a single-digit return within a year or two is acceptable because they can build wealth quickly in a less risky manner. Larger, institutional Silicon Valley investors are not generally interested in companies or entrepreneurs who have a short-term exit strategy.

Successful Execution


A number of start-ups have successfully executed on short-term exit strategies over the past decade, including Lasso Logic. The company, which was funded by angel investors, pioneered disc-based continuous data protection technology for the small and medium enterprise market. During the first seven months, Lasso Logic focused on developing its technology, while simultaneously putting together the team who was tasked with building corporate awareness among larger companies that could offer a distribution channel. Soon Lasso Logic began getting acquisition overtures from potential buyers, as well as interest from a large VC firm.


Within 18 months of its founding, Lasso Logic agreed to be purchased by SonicWALL for almost $20 million - giving investors up to a 5x return. After the acquisition, Lasso Logic became one of three business units at SonicWALL , which is now called the Business Continuity Unit. Once Lasso Logic became part of SonicWALL, its founders went on to start other new entrepreneurial ventures.

Like in the case of Lasso Logic, and many other early-stage companies that have followed a similar short-term exit strategy, building a business from the start with an eye to achieving an exit within the first 24 months may not deliver the huge multiples that are the dream of every investor. But it is a solid strategy that, if implemented on day 1, can yield a solid profit for investors, propel a product into market and enable entrepreneurs to explore their next venture.


By Steve Goodman, vp and gm of the network management business unit, Quest Software

 

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