Vanessa Grant, Partner, Norton Rose Fulbright, wants venture-backed startups to begin thinking about their exit on day 1. Vanessa explains why this matters, what VC investors look for, the role of corporate governance as a value driver, and how a conventional M&A process unfolds.
But you start thinking about that from day 1 — because those venture capital funds who are about to invest in you are also going to think about that. They’re investing to unlock value too, over some period of time.
So let’s pause for a minute and let’s just think about what the venture capital investors looking for.
They’re going to build a full financial model. And that financial model is going to start at the beginning and go right to an exit. And they’re going to look at data about what companies like yours will sell for, how fast those companies sell, and they’re going to be looking for data on how much financing people needed in order to get to that sale, and that valuation on the sale. That’s pretty robust data.
They’ll also be looking at things like your market share, how much of the market share you can capture. And again, I want to emphasize the value of time — how long it’s going to take you to get to that exit from the time of their investment.
Think about the exit from day 1 [01:20]
So I encourage all the entrepreneurs with whom I work to start thinking about the exit on day 1. Because that will inform what financings you do, how much money you want to raise, and most importantly, it’ll answer at least in part the question, “what’s my valuation?” The entrepreneurs with whom I’ve worked, who have taken the time to do that, have found that it really helps to focus them for success. And the other ancillary benefit of doing something like that, quite frankly, is it also starts your business plan.
So when you say, I’m going to exit for $200 million, I’m going to need two rounds of financing: series A and series B. And when I look at what other companies like mine have done, that’s sort of their trajectory as well, then you’re going to say, “ok, let’s say I need to raise $5 million at a series A and $20 million at a series B, and that’ll get me to my huge valuation.” What that will say is ok, so what are you going to do for that $5 million at your series A? Is that going to increase you, increase the value of the company, to the valuation where that $20 million series B makes sense? And then how are you going to spend that money? What’s your human resources plan going to look like? What’s your intellectual property strategy going to look like? What are you going to have in your corporate governance?
And let’s just do a teeny detour to the structure of venture capital funds. Venture capital funds are formed, typically, as limited partnerships. And limited partnerships are creatures of contract — and contracts have a beginning, and most importantly, an end. And a typical venture capital fund will, at the beginning, have about four or five years to make all those investments, and then it’s a seven- to 10-year window in total. So after that five-year window, they’ve got about two to four years to create value, and then ultimately realize that value, which is, in effect, our sale.
So the structure of venture capital funds and where these funds are in their investment is super important. And again, they’ve done the same thing and thinking about their investment in you, they’ve thought about how they’re going to take that $5 million or that $20 million, and turn it into a multiple of value, so that you have that $200 million exit.
Be realistic about your model & market [03:27]
So we’ve talked about the time part. But let’s talk about the multiple part. Everyone talks about how venture capital funds have to realize a 10 times value of their investment to exit. You need to be realistic — back to building your own model — about whether or not your market will support it, your growth will support that kind of one in 10 exit that the venture capital is looking for.
Corporate governance [03:51]
So let’s assume though, that we’ve had those series A, series B financings and we’re all ready for the exit.
The most important thing I talk about is corporate governance. It means that you’ve been thoughtful about your capital structure. It means that you’ve been thoughtful about your board of directors. It means that you’ve been thoughtful in the way you maintain your capitalization table. It means that you have been thoughtful in the way you’ve executed contracts.
And there’s a great phrase, “start how you mean to go on.” So, I find that entrepreneurs get very enthusiastic and very excited about what they’re doing. And that’s fair, they should develop their technology. By golly, that is the thing that’s going to create value. But never forget that there are other value drivers as well, which include corporate governance.
It’s as simple as making sure you did get all those assignments of intellectual property signed up right at the beginning. Make sure that you have regular board of directors meetings — you keep those minutes. Make sure that you’ve got an electronic data room already set up so that every time you sign an agreement, and it’s in perfect form, it gets uploaded there. The devil is in the details. But that will also lead to greater value. And what’s going to happen on your M&A, among other things, is the first thing people are going to ask for is, “I want to see your electronic data room.” People are going to descend upon it. And if you have a very large acquirer, they are going to have armies of people descend on your virtual data room.
And if everything is really well organized, and you’ve thought about why things are in your agreements, or why you did something a certain way, it’s going to make your life and your exit process that much easier. It’s going to increase the value of your company.
What does a conventional M&A process look like? [05:30]
If you’ve got a company that is what we’ll call a “hot company” in an industry that has high valuations and in an industry that’s a hot industry that people really want to make acquisitions in, you might have an investment banker, or an M&A advisor who’s going to run a process for you. And the M&A advisor would develop what we call a teaser to put out to potential acquirer. And that could go locally or it could go around the world. It really depends on the nature of the industry and who the likely buyers are. They could be strategics, they could be folks who want to bolt on a different technology.
Let’s say that there, there’s interest, then the first thing you’ll do is you’ll enter into a non-disclosure agreement — and footnote, non-disclosure agreements in the context of an M&A transaction are quite different from a standard non-disclosure agreement.
So your investment banker has got lots of expressions of interest. Sometimes what you’ll do, if you want a competitive process, is you’ll try to do some kind of auction. And you’ll have everyone sign a similar form of non-disclosure agreement. And then you’ll open up the data room and let people float around in the data room. Then usually, again, if it’s a competitive process, what your investment banker M&A adviser will have done is, will have said, “there is a deadline.” And sometimes if it’s extremely hot, you’ll actually have the purchase agreement, and you will have drafted it and sent it out and say, “hey, you tell us what you think.” But if it’s more of a negotiated process, you’ll have folks indicate expressions of interest through what we call letters of intent, or LOIs.
If you’re lucky enough to have the deadline, then you’ll have a few spread out along the desk and you’ll discuss which are the ones you want to engage in on a negotiation. And then at that point, it’s into straight M&A negotiation. But you’ll have ideas of the parameters of the negotiation, what you’re prepared to represent and warrant, and those kinds of things around the M&A transaction. That’s an auction-type process.
Other types of processes are: you may already have a strategic investor who’s invested in the company, who knows quite a bit about the company while they’re an investor, but they may express an interest in buying the company, in which case, you may elect to just talk to them directly. Or again, canvass the waterfront and see if there are other strategics, who may also have a similar interest. Again, the idea is to get into a competitive situation in order to unlock the most value.
Watch the market dynamics [07:51]
So we’ve talked a lot about time. And time is actually one of the most important things. So back to my, “get ready, because you’re always going to be surprised and you never know where it’s going to end up,” the short answer is you’ll also have to be watching the market dynamics. The time for your industry or the time for your exit may come earlier than you think. It may also come later.
One of the things you’re always doing and your venture capital investors will be doing the same thing as scanning the horizon for that specific value inflection point where you are going to unlock and realize the most value.