Fundraising 101: Exit Strategy Questions Asked During VC Interviews

This is the first part of a series of venture capital startup interview questions. In this article, we will be covering questions asked by VCs regarding exit strategy.

Unlike resources on the internet that just provide a few questions, this resource is unique as:

• We will provide the insight into what the questions actually mean (They can be sneaky).
• Almost all the questions you will be asked, rather than just a few indicative ones.
• Examples of what to actually say!

This instalment is on your exit strategy questions. Venture capitalists need you to make a big exit to make their business model work and for you to have a plan for that to happen. This is an area that very few founders give time to, which is ironic since it’s the only thing that investors really care about! If you read all of these and do your homework, you should be able to deal with every curveball thrown at you!

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Exit Strategy Questions

Question: Who is going to buy this?

What they mean

VCs care that someone is going to catch you. Their business is ‘buy low sell high.’ Someone buying you and for a high price is their business model. Someone acquiring you matters to you, but it’s all that matters to a VC.

You need to know who the potential acquirers and that there is a depth of them. It’s fine if you are an early stage to not be 100% sure what the future will look like, but with your current business model, you need to know who could buy you broadly. VCs are going to do thinking about this, for sure, but you need to do some thinking up front.

What you need to say

You need to have done some homework. Have at least five potential buyers. Ideally have a few that are not obvious, meaning not Google and Facebook. It’s fine for the acquirers to be local, particularly if you might be able to sell earlier for less, but still giving the VC a good RoI (RoI is time dependent).

The team and our advisors went through an exercise to think about this question. We know if matters to us and it’s super important to you. In the shorter term, other ad agencies make a lot of sense. We would be able to provide geographic coverage and access to great clients for them to cross-sell with their broader range of products. Longer term WPP may make a lot of sense. We would have to hit our plan to be sizeable for them to consider us. We hear they need us to make a min of $15m a year. We think we will hit that in year 3. Would we love to have your views?

Question: Why is someone going to buy this?

What they mean

No one is going to buy you for goodwill. They buy you for either financial or strategic reasons. If you are a financial buy, you need to make a lot of money and free cash flow, or high top line revenue. More likely is a strategic reason, such as they broaden their client access, generate cost synergies, revenue synergies, or even to help them remain relevant. Snapchat just bought Zenly to build their product. Google bought DoubleClick. Facebook bought Instagram. Why does someone buy you… specifically?

What you need to say

You need to understand the pain points of potential acquirers. What are you doing that they will need? What is a gap in their product?

We are building the simplest, easiest to use graphic design product. Adobe’s creative suite is amazing, but it is really hard to use. We believe this is the next phase of desktop publishing. Ease of use expands the market. Adobe is not easy to use and building such a product does not fit their strategy and unit economics. Buying us would enable them to expand their product range, without the innovators dilemma.

Question: What is the geographic fit with potential acquirers?

What they mean

If Salesforce just focusses on America, they aren’t going to buy you in Thailand. That is unless they buy you to expand to Thailand. More likely they want to leverage you to penetrate their own market more. Having said that, Groupon acquired someone in each market to expand globally. At earlier stages, local buyers are more likely. There is a reason SF is a great place to startup – there’s a depth of buyers. VCs need to know you have local buyers.

What you need to say

You need to understand why someone is going to buy you and not be naïve about US guys buying you, just because.

At this point in time and for the next 2 years, we see local buyers. We are building way to use payments in Thailand. The banks are plagued with legacy systems and we would be a very logical buy. Once we expand across SEA we will have a broader footprint which would appeal to PayPal and the like. We wouldn’t be interesting to them till then, my friend at PayPal told us.

Question: Do you know your potential acquirers? Do they have a history of making acquisitions?

What they mean

Do you know the market? Have you talked to them? Acquisitions are engineered. They don’t pop over the transom via email. Most acquisitions have some sort of bus dev deal first. They are also testing your knowledge. If you say some banks are likely acquirers, but they have never acquired anyone, then you are talking BS.

What you need to say

You ideally need to have reached out to the buyers about a bus dev deal or to get some knowledge. Of course, this is not possible, but it makes sense. It de-risks the deal a lot. You also need to do some basic research about their acquisition history to make anything you say sensible.

We reached out to three of the mid-sized players in our space, but have only got to chat to one person at Zenefits. We’d love your help on this if you were to invest. The top 5 guys on our buy list all have a history of buying. Zenefits bought x and Zenpayroll acquired y. They’ve all raised a lot of money recently, so imagine in future they will have dry powder to buy us.

Question: Are there many buyers for this?

What they mean

They’re testing you to see how much you know. There’s also an element of scepticism. You may need to pitch your value more. They want to make sure you believe there is a pool of potential buyers, otherwise they may never get their money back. You set up your start-up to solve a problem for a bigger company than you to buy. It’s not really about solving a customer problem ;).

What you need to say

Of course there are! If we achieve our mission of making our customers delighted, then why wouldn’t someone want all these happy, paying customers! We see three categories of buyers, banks, payment gateways and service companies. All in all, we have mapped 35 buyers.

Question: What did they sell for? Who bought them?

What they mean

Do you know your industry? Are you an insider, are you an expert?

What you need to say

“We know Bob in Corp Dev. He told us some things in confidence that we can’t share. What we can say is the founders were quite happy with the deal and so were the investors.”

Question: How much do you want to sell for?

What they mean

VC is a hit-based business. They don’t make money from a $20m acquisition. Read this to understand more. VCs don’t invest in a lifestyle business, they need you to be big. So, they want to know, know need to, that you are ambitious and want to swing for the fences so they and their LPs make a lot of money if you don’t fail to try.

What you need to say

You need to want to sell for a large amount! Selling a billion is a very loaded answer though, so be careful.

We love our mission to solve on demand carrots. But, we aren’t a charity and want to be rewarded for delivering orange happiness! Other companies in the space have sold for nearly a billion and others for hundreds of millions. We would happy to sell for $100/200m in 4 year’s time. A lot has to go right for us to be a unicorn, and I know it’s a cliché, but the market of carrots is big enough to support an exit for that. I think we would all be delighted if that was achieved together. Do you agree?

Question: What can you sell this for?

What they mean

They’re just trying to figure out how much you want to sell the company for (how ambitious) and also add to their thinking about what and how an acquisition will happen and from whom? So, it’s both a sneaky question and a logical one.

What you need to say

I guess when is important here. In the next 2 years, if we hit our milestones, x and y would be interested in building out their product. We see a multiple of 8x reasonable. So, if we are doing $15m run rate ARR that’s $100m. Obviously in 7 year’s time that’s different. We could be doing in the range of $50-80m which is grounds for a financial acquisition, so I think that math works well.

Question: What is the exit multiple?

What they mean

This is a test to see if you understand your business model and industry. You need to check previous acquisition multiples in the private market and what companies have been trading at in your industry. Check them before you meet investors.

What you need to say

Five companies were bought in the past 3 years between 3x and 7x. The 7x was for Salesforce which sells difference things to us. Zendesk was 6x which is more similar to us. Groupon is trading and 10x which is obviously higher given the liquidation premium.

Question: How are comparable businesses valued; both on the stock markets and in M&A transactions?

What they mean

This is the same question as ‘what is the exit multiple.’

What you need to say
This is the same question as ‘what is the exit multiple.’

Question: What acquisitions have there been recently?

What they mean

Do you know the market? This is similar to other questions.

What you need to say

There have been exits in two key trends: payroll and payments. In payroll, Zendesk sold to Facebook and in payments Gusto sold to Bigpanda. We think the Gusto sales was really interesting because of…

Question: Are you a strategic purchase?

What they mean

They want to get to get to you think what you are doing is valuable to someone else? How are you different and special? Why specifically would someone buy you? What problem do you solve for a buyer, not the customer.

What you need to say

The UK is a massive market. This is our home and our focus for the next 2 years. We will of course expand to Germany and France, where we see the need, but this is our home market. We know Salesforce will need a bigger play here to perpetuate their growth story. We know the market very well. Once we have built out our core integrations and supply side of the marketplace, we will be very compelling platform upon which they could enter the market. I believe that would be strategic to them.

Question: If you want to sell for a billion or more, as you say, why will someone pay that?

What they mean

You told them you want to sell for a billion didn’t you. Hm, ok! You better have a good answer. A billion is a lot. The bigger you are, the fewer potential buyers there are. So, you have to be strategic, like say Instagram and WhatsApp were for Facebook. What core problem and trend are you a part of selling in?

What you need to say

Mobile matters. The big guys like Facebook still don’t have their strategy and product right. We are experts at mobile. John founded Instagram and Mary was Head of Mobile at Google. We have our strategy to stick to and if our thesis is right, there are 7 companies who will fight for us as there are very few other buyers. You get a big price with scarcity and a bidding situation.

Question: Do your potential acquirers have the cash to buy you?

What they mean

They either don’t believe you when you say who you think the buyers are, or they don’t know the market of France as they don’t normally invest there. So, they are genuinely interested in learning, or they are testing you to call your bluff.

What you need to say

Facebook, Google and Apple have $350bn with a B in dry powder offshore. Locally Priceminster and x have $500m on their balance sheet. For a couple hundred million exit, we think that’s quite reasonable to cover in a cash deal. They of course can issue us stock too.

Question: Do you want to IPO?

What they mean

They’re testing to see if you actually understand what an IPO is and means, and how open you are to exit options. IPOs suck, but they’re another means for investors to get their money back.

What you need to say

IPO has its advantages and considerations. We see great opportunity in using shares as acquisition currency to build out our product offering. We are worried of course that quarterly reporting could impact our long-term flexibility to be more innovative. We’ve seen the inability of GrubHub to adapt to new entrants. Having said that Google has handled it really well by… All in all. When the time is right, it might make sense. Let’s build an amazing product first.

Question: Do you want to sell this?

What they mean

Investors need to exit, you need to too. If you aren’t starting up to sell out, this isn’t going to work. But VCs need a big exit so they’re wondering what your plan is and if this aligns with their needs.

What you need to say

Of course we do! We know how VCs work, so we wouldn’t be here if we didn’t have an exit strategy. Why don’t we discuss our exit plan and we would love your views on it.

Question: When do you want to sell this?

What they mean

It takes time to build a big business. They need you to be committed for up to 7 years or more. If you sell next year then you are not value maximising. The return they get will not be big enough. They’re asking how committed you are for the long-term.

What you need to say

There’s always a price. If someone offers $50m tomorrow we would be crazy to not take it right! But that’s not going to happen. It takes a long time to build a massive business so the team is aligned and committed that the biggest exit will be in around 7 years, which is what it historically took to get to IPO. You can’t time an exit, but when we create compelling value the big boys will come knocking. When we should sell is something we would take advise from the Board.

Question: What price would you sell this for now?

What they mean

Like the above question “When do you want to sell this?” they’re seeing how committed you are. They are also getting an idea for your valuation expectations for this round and how ballsy you are. They want you to want to make money so that they do too.

What you need to say

Everyone has a price. $50 Mn would be a big deal for a year’s work. We wouldn’t sell for less than $30m since what would we do after? We would just set up another company. We see so much potential here and the timing is perfect with the trend in digital signing. We really see a pop in 2 years. It wouldn’t make sense to leave so much money on the table now. But of course, there’s no harm in listening.

Question: Do you know your competitors?

What they mean

This is very similar to a lot of the other questions. On the face of things, they are asking whether or not you truly know your industry very well, or not. More deeply they are trying to understand how smart you are. Since acquisitions don’t just happen they need to be engineered and that comes through relationships. To investors, the best founders to invest in our industry insiders and will be able to get deals done.

What you need to say

Well as you know Frank, I’ve been in this industry 15 years, and worked at some of the blue-chip companies. In fact, two of our main competitors for setup by my former colleagues, and we see each other at the usual fintech events on panels. It would be safe to say that I know something about the industry.

Question: Has anyone approached to buy you?

What they mean

Investors are just trying to get an understanding of whether there is an interest in you and the market already. Obviously, if people have already approached to buy you, then they will likely be interested in the future. So, if the investor gives you money to grow and become more valuable, then it is an easy win for the investors.

What you need to say

Our product has only been in the market for six months, for now we are too small for the potential acquires that I have in mind. I didn’t quit my job at IBM to sell this for a couple of million dollars. Having said that I was talking to Sunil at PayPal and they are having problems with their subscription payments. He was interested in having us talk to their business development team to see about an integration. As you know deals don’t just happen they happen through relationships. I’m confident that if all goes to plan that PayPal would be a logical buyer for us and I ready have some relationships there.

Question: What will my return be?

What they mean

Like many of the questions, investors need to make money to give back to their limited partners. It’s not really the founder’s job to do the return maths for investors so what they are really getting at is how big of an exit are you looking to do, furthermore they may be trying to understand if you understand the venture capital business. A good answer would not simply just state a number but show the logic of how you get to a range of numbers.

What you need to say

That depends on when we sell the company as well as a number of other factors such as the exit multiple, if we are in a competitive situation as well as to a lesser extent how much money we raise. To Maximize the value of this venture we are looking to either do a large trade sale to one of the large companies or do an IPO. That quote more than likely take us 6 to 7 years. Under our business plan we could be doing in the range of about hundred million run rate. Assuming exit multiples in the range of 6 to 10 we are talking $600-$1 billion. Typically, enterprise size companies raise around $70 million to get to this position and since we are talking series hey for $7 million that would imply another four rounds of investment where you would be diluted too. We are looking to do our round at around $20 million pre-money. I’m sure that you can do the math but these are our expectations and our plan.

Question: What is your exit strategy?

What they mean

This is again similar to other questions but it is a lot broader, giving you the opportunity to provide a structured answer and show how logical you are.

What you need to say

Acquirers will only by a company they are solving a problem over the longer-term. Our focus now is not on exiting but solving a real problem for customers if we can make the customers really happy then potential acquirers well follow. A trade sale and IPO are both potential options over the longer-term. Of course, if someone was to come along and make a crazy offer in the next few years we would consider it, we would be crazy not to, right? So, our plan is 1/ build a product that customers love and gets us brilliant attraction, 2/ develop a marketplace which will create barriers to entry, 3/ develop partnerships creating a track record or relationship with them. If we are able to disrupt the market we will get offers to exit.

Question: When are you paying me back?

What they mean

Execution is everything, ideas are not worth anything- try selling one. Every investor needs to know when and how they will get their investment back and then some. The great thing about this question is investors will only ask it if they are getting interested. The easy thing to do would be to answer this question literally and tell them your timeline and how much you want to sell for, but this is a great opportunity to also sell yourself. Remember you are in the sales meeting, so sell the strength of your team, your key achievements and traction, the problem in the market that you’re solving and how you’re solving it, and finally how massive the market is.

What you need to say

Assuming that it makes sense for us to go ahead with this partnership, it’s important for us to be aligned on the kind of company we want to build. Our downside aspirations are to build $100 million company. Mary and I have both exited companies before for low digit millions. We have bought our house and the kids will be okay. We’re doing this to swing for the fences. If a lot of things go right then we would love to build unicorn, obviously that is a cliché but we see the opportunity in the size of the market. This will mean that we need to raise another four or so rounds of capital, there’s no way around doing so given the payback period on our acquisition costs. You need to buy into that plan. I would love to know if you have the dry powder to do follow-on rounds? To build a large company takes time and we see that as being at least 5 to 7 years, I presume that fits into where you are and your current fund life?

[This post by Alexander Jarvis first appeared on the official website and has been reproduced with permission.]

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