The other night I was in attendance at the BC New Ventures competition, listening to Mike Volker speak about the business case for new ventures. While he touched on a number of key points, one stuck out in particular – coming to a pitch without an exit strategy.

When entrepreneurs are formulating their business plans, they focus on the traditional elements, which include: the market, the competition, the financials and the strategy. These elements are essential for outlining how a company will build a business model that will generate returns for investors. If these elements are in place, and the company creates a compelling value proposition, then investors have no problem putting their money in.

While many investors and financiers want to invest in, and share their expertise with companies that are fun and exciting, at the end of the day they need to make a return on their investment. The only way they can accomplish this is if they can exchange their shares for cash, meaning companies better have an exit strategy.

Mike pointed out that many presenters pay lip service to this point, and simply stick a slide up saying that they plan to bought out in x years for x multiple by x company, which is usually Google. Either that or they want to go public. The problem with statements like this is that while they are great in theory, it would be great to know how to the plan will become a reality. This requires some high-level thinking, financial analysis, and strategic planning.

Financially speaking, it is imperative to understand what a company would be willing to pay in order to make an acquisition. The rule of thumb is that a company will pay 3-5x EBITDA for product companies. EBITDA is significant because it represents earnings before interest, tax, depreciation and amortization – it captures the true value that a company earns from operations. The two other prominent methods of valuation are based on DCF (discounted cash flow) and revenues, while many valuations are triangulated using all three methods. Different industries will give different premiums depending on their stage in the industry life cycle, so it is important to understand the macro forces shaping the industry when trying to arrive at one of these targets. The bottom-line is that your valuation needs to be based on a methodology commonly employed by financiers.

Strategically speaking, it is essential to be able to make a compelling case as to why your company would be a good target for Google, Blackberry, or whoever the leader is in your industry. These companies are constantly making acquisitions, but each one has a significant strategic relevance. It requires an understanding of how your company’s product will play a role in bolstering that company’s brand and bottom-line, and from that understanding you can build out a strategy that makes sense.

Finally, it is important to be able to put together a cap (capitalization) table that shows an investor what their piece of the pie will be worth when the exit strategy is executed. These can be created using a simple spreadsheet, but the numbers within the spreadsheet need to be well thought out and strategically validated.

An exit strategy is something that takes a lot of high-level strategic thinking and foresight, and should not be thrown on one slide the night before an investor presentation. It is however, very valuable to consider the company’s exit before entering the market, as it may have a significant impact on the strategy going forward. The key to the whole presentation is that investors feel compelled to put their money in and know that there is a strategy in place to get it back out.

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Encompassed within this article is the very important element of understanding your audience. It is true, entrepreneurs must be able to take the perspective of the financier and build support for their pitch in accordance with their questions and concerns.

In terms of understanding the exit, venture capitalists aren’t looking to create family businesses. VCs are concerned with value creation and the exit, and doing so in the perfect amount of time that leads to the high IRR they seek.

In addition, exit strategy has an importance for entrepreneurs beyond the pitch. When negotiating the term sheet, entrepreneurs should understand the implications of the different means of exits. With incorporating liquidation preference as a common practice among VCs, entrepreneurs must recognize that through any type of exit, aside from an IPO, their financial return will not match their percentage of stock. Therefore, if an IPO is an unrealistic exit strategy, yet the value creation is highly probable, then the entrepreneurs should take this share dilution into account in the percentage of equity they are willing to offer for capital.

Colin Lyons May 8

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