How to Develop an Exit Strategy for your startup
In this ongoing series of articles concerning the five-phased agile business operations system for startups, Business Operating Support System, of BOSS, we’ve covered the various steps in the development of the North Star. A startup’s North Star is the definition of the desired business outcome of your startup which includes what you are selling, why you are selling it, who are you selling it to and how you will exit.
Briefly, BOSS is an agile operating system that incorporates ideas and best practiced from the most effective methodologies in business, software and manufacturing. It creates efficiencies through a structured approach with five phases that set the vision (or North Star), strategy, execution, standardization and business improvement processes needed achieve alignment on company objectives, goals and measurable results utilizing leading and lagging KPIs.
The first phase of BOSS, North Star, consist of the above mentioned steps; What, Why, Who and Exit. In this article, I’m going to focus developing the elements of developing an exit strategy, specifically determining when you will sell and for how much.
As an entrepreneur launching and building a startup, it’s important not only to determine what you are selling and who you are selling it to but also to figure out an exit strategy to work towards, Here we will take a look at the elements that make up the genesis of an effective exit strategy; how much you can sell for and when you can sell.
How Much Can You Sell For?
First, you’ll want to take a look at how much you think you can sell for. The graphic below lays out all the elements involved in making that determination and it’s done from the perspective of the buyer with you, the seller, insuring all of this information is predetermined.
Firstly, the buyer will have to determine why they want to acquire; either to help their existing revenue or to boost profits. Both, of course, are important but one will be a driving factor. To answer this question, you will need to look at how your startup will contribute to each of the buyer’s interests. Is your startup better at revenue growth or profit growth?
Second, look at what the buyer hopes to acquire Are they more interested in acquiring the company; in other words the intellectual property and/or the resident knowledge and expertise of the executive team. Or is the buyer more interested in how your product can benefit the company. Knowing which is the most important will drive how you position your startup’s benefit to the buyer.
Third, you’ll take a look at the buyer’s viewpoint on top line revenue versus bottom line revenue. The top line refers to a company's revenues or gross sales. When a company has "top-line growth," the company is experiencing an increase in gross sales or revenues. The bottom line is a company's net income. Clearly every company has both but in the eyes of a buyer, one is usually more important than the other when the buyer considers their own goals with respect to the acquisition. You need to know which one is most important to the buyer and, as well, which one your startup is best at contributing to.
Fourth, you’ll look at the drivers that motivate the buyer. There are four elements here; revenue growth (actual and percentage growth year over year), retention rate (customers retained from one period to another), profit margin (how many cents of profit a business has generated for each dollar of sale), and base and attachment rate.
Perhaps the most important of the four drivers, base and attachment rate, reflects how many of the seller’s customer base the buyer can expect to successfully service following the acquisition. If the buyer has 1,000 customers and you believe your startup can service 200 of those customers, the attachment rate is 20%. This is useful to determine sale price in that a buyer could determine they will pay a certain multiple on that 20% attachment rate over, say, a 36 month period.
Fifth, like the retention rate multiple just mentioned above, you’ll need to explore the top line and bottom line multiples the buyer has in mind and apply them to your top line and bottom line revenue to arrive at a sale price.
After exploring these five elements, you can roll them up into a nice and neat buyer statement that can be used both to grow your company (as a forward looking document) and, when ready, to entice prospective buyers with a statement filled with actual numbers.
When Can You Sell?
In order to know when you can sell, you need to know when you can meet and deliver on each of the above elements in the How Much step. Let’s take a look at the element of determining when you can sell.
There are three categories to look at when ramping up to an exit: revenue, profitability and actual exit metrics. Revenue encompasses a working product with paying clients and product validation.
Profitability encompasses expense, income and profit, and determines you break even point. Exit encompasses the achievement of the metrics you worked towards when determining how much you can sell for: growth, retention, margin and attachment rate. Goals are established for each of these categories. They are then plotted out on a chart similar to the one above. When the end goals have been reached, you are ready to sell.
Putting these two elements, how much and when, of the Exit portion of your North star will help set you on the right course towards growth and eventual exit.