The Exit Strategy Taboo

Venture capitalists are people who invest in startup companies in exchange for a certain equity stake. They are ready to take higher risks to gain higher profits in the future. Wealthy investors, investment banks, and other financial entities may be among them. A creative company concept or an innovative technology startup is usually easy to get shortlisted by venture capital investors. The capacity to detect the growth potential of innovation is one of the most significant competencies of venture capitalists. They also have a considerable ownership share in the firms in which they invest, allowing them to engage in management. At the same time, an exit option is one of the most crucial tactics for venture capital investors and startup founders.

An ‘exit’ is when a founder leaves a startup.  Many founders plan for their exit from day one, perhaps even hoping to build a unicorn company (a private company with a valuation of over $1 billion). They created the startup with the plan of cashing out at some point by selling ownership of the company, either to investors or to another company. Exit strategies are plans established by an entrepreneur or founder to liquidate their ownership of a business to investors or another company. The most common exit strategies for startups are acquisitions, mergers, and IPOs (Initial Public Offerings). On the other hand, an exit plan may be used to quit a non-performing investment or to end a loss-making firm. In this situation, the exit strategy’s goal is to reduce losses. A venture capital investor may also implement an exit strategy to plan for the cash-out of an investment.

Acquisitions are a much more common endpoint for startups than IPOs. So why does no one talk about them? For every IPO, there are over 30 acquisitions each year. However, while nearly all founders and respective board members know that an acquisition is the most common destiny of a successful startup, they rarely strategize about a potential sale. Instead, they strategize exit plans when their startup either desperately needs to sell or has inbound interest from an acquirer. As a result, they either miss out on significant strategic opportunities or end up with a suboptimal outcome. Acquisitions can take years to come to fruition. Therefore, the only way out of this unfortunate predicament is for founders to devise an exit plan early and lay the groundwork for a potential sale to acquirers long before a sale is imminent.

If exit planning is so important, why is it so commonly neglected? There are several myths and biases about selling a business that have rendered exit planning discussions a taboo topic in the startup community. The five common myths and biases that get in the way, and prevent founders from thinking ahead include:

• Present bias
• Optimism bias
• Signalling failures
• The myth of entrepreneurial risk-taking
• The myth of acquisition failures

Understanding these, and knowing how to work around them can ensure founders have the broadest slate of possible options and aren’t left scrambling when an acquisition deal is suddenly on the table.

Present bias

Generally, we tend to show a bias towards the present, prioritizing near-term outcomes over long-term results and significantly discounting future risks and rewards. Because entrepreneurs spend their days fighting multiple fires and face significant resource constraints, they are especially prone to this bias. Strategic planning is considered a luxury by many entrepreneurs. This present bias creates strategic debt that accumulates over time and can cost entrepreneurs their business. We can’t improve what we don’t pay attention to, and delaying talks and considerations related to a strategic exit today renders entrepreneurs utterly unprepared for the single most outcome-defining event in their startup’s lifecycle-the exit.

Optimism bias

Optimism fuels entrepreneurship, but it can also give rise to a false sense of confidence and create strategic blind spots. Most founders know that the chances of success for any startup are slim, yet they don’t consider themselves to be subject to those statistics. Startup founders overwhelmingly focus on the least likely outcome, that is, taking the company public. The problem with this outlook is that no entrepreneur can make proper strategic plans and overcome the obstacles in their path without a realistic view of their future prospects and the nature of those obstacles. To keep this blind spot in check, founders need to take time and create a long-term plan that reflects the realistic chances of an IPO versus a strategic sale as the ultimate destiny of their startups. They also need to periodically revisit and revise this plan as they gather new data on their own progress, changes and consolidations in the industry, as well as evolving market conditions.

Signalling failures

Venture capital investors tend to be attracted to mission-driven founders who have the courage to take major risks and aspire to build scaled businesses. Moreover, they expect founders to have the unwavering commitment to stay the course during times of hardship. Since all startups go through periods of hardship, without such strong resolve amongst the founders and leadership, it would be almost impossible to turn things around and survive. As a result, investors dislike founders who show signs of a built-to-flip mindset. They worry that these individuals lack the resilience and perseverance to innovate their way around inevitable obstacles in their path and will end up selling their business too quickly. The result of this is that investors typically avoid getting into any serious exit planning conversations with these founders.

By understanding this aversion, however, startup founders can adopt the right approach. This entails establishing the proper context and addressing investors’ concerns and discomfort directly before discussing exit plans. The best way to do this is to emphasize how it’s in both parties’ interest to prepare for all possible contingencies, protecting against downside risks while maximizing the upside potential.

The myth of entrepreneurial risk taking

Many assume that because innovation involves risk, risk mitigation strategies would hurt an entrepreneur’s underlying motivation to innovate. They worry that having an exit strategy would make it too tempting for a startup founder to rush to a quick sale rather than work through the hardships and reach for the stars. On the contrary, those fears are misplaced. While there is no evidence in support of the claim that risk mitigation hurts innovation, there is mounting evidence about the harmful side effects of excessive risk and the toll it takes on the mental health of entrepreneurs. Innovation is not forged in overburdened entrepreneurial brains. Instead, innovation is a result of repetitive, iterative, and creative experimentation. Stress associated with excessive risk only makes success harder to achieve.

A viable exit path makes running a startup much less stressful due to what’s known as the “panic button” effect (believing one has the option to escape a stressful situation will reduce the amount of stress experienced in that situation). While entrepreneurship involves some level of risk, entrepreneurial passion and commitment neither springs from, nor grows stronger with excessive risk. Instead, what motivates entrepreneurs is their conviction that they are involved in the creation of something that will have a lasting impact. This is exactly what a viable exit path enables.

The myth of acquisition failures

The media’s focus on acquisition failure stories has perpetuated a false narrative and popular misconception that most acquisitions destroy shareholder value and fail to achieve their stated goals. Anyone who is under that impression, of course, would be reluctant to seriously embrace the idea that selling their business is a viable path towards achievement of their company’s mission and fulfillment of their aspirations. Any startup founder who wants to engage in serious deliberations about their exit strategy with their stakeholders needs to be familiar with the actual data and respond to any stakeholder skepticism about acquisitions. It is important to note that acquisitions don’t just happen based on a whim. Much detailed analysis and planning goes into the process with many people and approval levels involved on each side of the transaction. The acquisition failure stories just tend to be more popular.

To tilt the odds of success and survival in their favor, startup founders need to devise and implement an exit strategy long before they consider selling their business. The first step in that direction is to overcome the exit taboo and open the communication channels with their key stakeholders.

Article by Michelle Nthemba

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