It’s not necessary to do extraordinary investments to get extraordinary exits
It’s said that exit ignorance while investing in startups is not bliss; it’s rather a very expensive affair. For entrepreneurs, creating an exit strategy for themselves should never begin at a very early stage but for investors, it’s a must. Exit opportunities come in different forms, but it is important that the founders are cognisant about providing a return on investment.
Decoding The Role Of Angel Investors
An angel investor’s role and relationship are time bound with any startup. I personally have been a technology entrepreneur with two successful exits. Now I do active angel investing with 50+ portfolio companies hence, the commentary here is with that perspective. Lead investor interaction with startups play a crucial role in value creation which impacts the exit returns significantly:
1-2 interactions yearly results 1.3X returns 1-2 interactions monthly results 3.7X returns
Entrepreneurs should choose active angel investors who have experience in managing exits and their ability to sell the startup. For entrepreneurs, it is one of the most vital decisions as it impacts their future rounds of investments in the company.
Facts And Figures
It’s important to have an alignment on exit strategy between entrepreneur & investor so that expectations are managed on both the sides accordingly. For passive investors to follow the lead investor’s deal is also one of the most difficult decisions to make for while investing through angel network because it’s impossible to do an objective comparison of lead investors which one is good.
Startup investments are not like loans which are to be repaid with interest. The angel investor sees a return on investment when sells his stake for cash. Angels should not lose patience & not expect high yields after three years of investing.
In India startup IPOs are non-existent, we hear once in a while of a big ticket exit in media but under the radar where angel play, exit transactions are in the range of $10 Mn – $20 Mn. There are no cookie cutter approaches to arrive at exit multiples or returns but as rule of thumb, the below table shows what angels should expect over a period.
1X typical 2.5 to 3 years
10X is expected to take 4-5 years
30X could take 8 years or more
Unicorn 10-15 years
Not all exits are happy ones: half of them are below par, sub-optimal, distressed sale but at least the investor gets his capital back either in cash or equity swap. Many investors funnily see an exit discussion with the entrepreneur as a negative thought process rather than guiding them towards value creation.
An exit strategy is not akin to quitting but planning to maximise the returns with funded startups. If a startup misses the ideal time to exit, then the most likely result is that it will be in failure or in a living dead state.
Entrepreneurs should also look at investor exit as just another business event during it’s lifecycle. It’s logical conclusion to the journey of raising growth capital with best possible returns.
When you sell any asset like gold, real estate etc. there is price discovery on the basis of a market. In the startup world, we do not have ready reckoner to look upon. The valuation does not have any science as it is not based on fundamentals as in the case of publicly listed equities. Price usually is an educated guess basis expert observations within prevailing market with perceived risks.
While we are still discovering the best practices on exits, here are some exit opportunities that are most important for me:
- Financial exit when a VC (financial investor) buys out the angel investor equity. I find this as this as the best possible double-digit exit returns that angel investors can make.
- Strategic exit when an acquisition (strategic buyer) happens resulting in the buyout of the angel investor stake. I find this as average exit where in limited cash returns can be expected.
- AcquiHire exit when a startup which is going south and a forced merger happens with an equity swap to stop further erosion of investor capital.
While investing in the right opportunities is important but equally important is legal documentation that protects angel investor rights. For e.g. one of the terms important in exit events is liquidation preference.
It is a term used in venture capital SHA (shareholder agreement) to specify which investors get paid first and how much they get paid in the event of a liquidation event such as the sale of the company. The goals of VCs and angel investor are never similar to their shares in upsides are different. Last In, First Out (LIFO) describes the normal situation in liquidations, where VCs who were the last to invest get paid before angels who invested earlier.
Hire legal expert professionals for documentation to mitigate downside risks. Do not take the self assessment or online template approach for SHA.
Exits are arbitrary, but still, it requires full-time efforts to see the success. Investors need to look at anywhere between 6-12 months to achieve an exit. Not all startups are ready for an exit.
Even if it’s ready for exit only one-third of them see success. It’s a long-drawn process and founders should not be leading exit transaction as it impacts business directly. Also, you do not want rookie founders learning to navigate on how to manage investor exit with VCs or Strategic buyer.
The prudent way is to have a marquee IB (investment banker) take up the mandate to maximise possibilities of the desired exit to happen. The IB then leads the way to preparing the startup founder for exit pitching to generate enough confidence for the incoming investor on the asset he is buying.
The IB is your salesman, out there selling your startup to potential investors/buyers. If the startup founder does not play ball then even best of the IB cannot make the exit happen. There are fortunate but unplanned exits wherein there is an inward offer from buyer or investor. The IB in these cases can then increase the probability of success alongside maximising on the value creation for investors in shortest possible engagement time cycle. These type of lucky exits are exceptions.
Create an exit team with founder and investment banker to increase your exit probabilities and watch the returns multiply.
The summary is that angel investors should not rely on VCs or accidental offers to exit. In the current scenario, investor exits are possible with multiples, that too in a short period of time provided there is an exit strategy in place.
[This post by Sanjay Mehta first appeared on LinkedIn and has been reproduced with permission.]