by Katarzyna Pac-Malesa, Investment Director 3TS Capital Partners
Exits are an exciting and gratifying moment for companies, and their management teams, employees and investors. For many founders, an exit is a once-in-a-lifetime event that could determine their wealth for many years or even decades. Exiting does not just happen, it’s a process like any other. Bearing the importance of the process in mind, exit planning should optimally start two years before the expected exit timeframe. This increases the probability of maximizing enterprise value and avoids last minute surprises that can negatively impact value and momentum. Preparations could turn out to be even longer in the current COVID-impacted circumstances, as business owners need to plan well their efforts to recover after revenues contraction in recent months.
Below I am highlighting best practices to consider when preparing for a successful exit.
Begin with the end in mind: Define exit prerequisites and a range of acceptable, reachable exit values
It may sound sophisticated, but this comes down to having a common understanding between shareholders about what a successful exit is, what makes the business exit-ready and how to plan to get there. To answer the former, one needs to connect all the dots that make an exit successful: timing, desired exit value, valuation multiples and revenues level. The criteria of the latter depend on the sector and could be such as level of revenues or EBITDA as buyers’ interest usually increases in step-functions after reaching certain thresholds, number of enterprise clients, market presence in certain geographies or adding a new product. Having all this agreed and planned out as early as practically possible helps structure the management’s thinking about next steps, investment required and allow for time needed to amend the go-to-market strategy to achieve the desired growth.
An important part of this exercise is to determine ahead of time who are potential buyers. Is the business more likely to be acquired by a strategic or a financial investor and what drives their interest? What are their rationales to buy: market presence, growth, revenues and client base, geographic expansion or maybe strong proprietary solution? The more one knows about potential buyers’ motivation, the better they can prepare. Identify a few relevant investment bankers that are active in the company’s segment and meet two-three times per year. They spend time with strategic as well as financial buyers and can be a guide on what interests those acquirers over time. The next step would be to connect with high probability buyers and begin establishing direct contact or partnerships. It’s worth noting that two thirds of all M&A transaction are proceeded by a revenue-generating channel partnership. In successful exits, companies get bought, not sold. Make your company into a must-have asset to buyers.
Fortune favors the prepared mind: Start preparations well in advance
The team is a key success factor not only while growing the business but profoundly at the exit. Make sure you have a complete, dedicated, and incentivized team well in advance that will run the company through the demanding exit process and beyond. Have open discussions with the management team to understand who plans to stay on board post-transaction. Save some time for building a sound management structure and demonstrating a credible succession plan for every role. If you managed to arrive till this point without a CFO or COO, now is the last moment to hire them and fill other competency gaps. Employee stock option plans vesting at exit will align all stakeholders’ focus on a common goal and help to avoid an unplanned departure in the middle of the process.
Funding is as important at the beginning as at the end of the investment life cycle. Running out of money during the exit process will not only create additional pressure but could also hinder the growth pace, revenues forecasts, and negotiation position. Ensure the company is secured with enough (6-12 months) runway ahead of an exit or a sustainable path to profitability. Negotiating from a position of strength is key.
It goes without saying that operations and finance need to be sorted out and streamlined well ahead of the exit process. The accounting and ERP systems should work seamlessly to provide reliable and consistent financial and operating data to populate dozens of models, forecasts, and tables. It is too often the case that companies are losing momentum on reconciliating numbers. Save at least a year to improve internal processes and KPIs that are usually in the center of potential buyers’ interest: MRR, Churn, LTV, CAC, ARPU, gross margin, sales and marketing conversion ratios, unit economics, products mix and payment cycles. Make sure to mitigate risks of a large client dependency or a crucial client renewal in the middle of the exit process.
This is a team effort: Engage an M&A advisor
Preparing for an exit is a complex project and even the most experienced business owners supported by a private equity fund may struggle. Hiring an M&A advisor that has “been there and done that” many times before, in the company’s market or segment, can be the key to a smooth process and maximized valuation. As it may be tempting to save on the advisor fee when approaching local buyers, don’t — investment bankers are a must-have for larger businesses pitching to investors in the international domain and bring credibility that there is a formal process in place. Buyers usually take advantage of and see weakness when an investment banker is not involved.
A professional dealmaker will not only structure the process, take on preparing transaction documentation and approach dozens of potential buyers within their network. It will also offer an external perspective to challenge business assumptions and identify points of weakness ahead of difficult questions are asked by a potential buyer. It can’t be underestimated that an M&A advisor manages the whole exit process and to a large extend takes on transaction execution. This prevents the management from getting distracted from the day-to-day running of the business and delivering results.
A good practice is to spend some time with a few potential investment banking candidates before selecting one, to be sure they understand the vertical and have suitable track-record and style. The best of them will also use this time to scrutinize the business and verify its KPIs against the industry benchmarks to make sure they are engaging in a promising cooperation, while actually providing great consulting services to the company.
Paraphrasing the great philosopher Seneca, a good exit happens “when preparation meets opportunity”. Most tech companies have a defined window of opportunity for an exit and an optimal time to sell. Afterwards, the market can get consolidated, the technology outdated or the economy hit by a global pandemic. Being operationally and mentally prepared to activate a structured exit process when the time comes or quickly respond to an attractive buyout offer, significantly increases the chances of maximizing the value of the business and taking advantage of bullish markets.