Preparing for an Exit

The challenges of securing growth capital from a Fund and spending it in the best way are topics we cover often, but how much time and effort should be spent on thinking about an exit?

Our members are sceptical about this other than doing the right things in scaling a business anyway as well as keeping proper, up to date records. An IPO as a potential exit for some shareholders is also worth consideration given the current enthusiasm in the public market for technology businesses.

This article is an extract from a talk delivered by Paddy MccGwire Managing Partner of Silverpeak LLP and a member of ScaleUp Group to our CEO Forum on this topic, exploring the key areas you should focus on.

Which hat are you wearing?

Know which role you are in when determining an exit strategy

• a Founder, with the extraordinary zeal necessary to get where you have?
• an Executive with a ‘role to perform’?
• an Investor whose primary wealth is tied up in the business?

Company Profile

Elevate your brand awareness and reputation as early as possible to alert the market to your existence and better still your prominence in your category.

Priming the Market

You should also prime your market early, to anticipate the future direction of your product/offering to establish a leadership position, ahead of your product availability/functionality. The market prices in future performances and applies a discount rate to arrive at a value today.

Key Ratios

Ratios determine valuation. The most valuable one is Sustainable Growth, reinforced by credible stats re Total Addressable Market; Customer Acquisition Costs; Churn – both Gross i.e. before uplift sales and Net i.e. after uplift sales.

Bookings – Total Contract Value

Acquirers look at this as the lead indicator of sales penetration and then how the Bookings convert into Revenue, into ARR and into Cash – all to help determine your Sales & Marketing performance and scalability.

Quality of Revenue

Quality of Revenue is also key to a premium valuation in terms of spread and diversity over sectors and number of customers/partners.

Buyers

Broadly speaking, they fall into two categories:

1. PE Houses – not strategic, but finance driven. These entities often move faster than strategic buyers and perform deep dives into financials and KPI’s. It is important to note they always have their exit in mind, hence they will base valuation on Industry multiple/ratios and target a specific hurdle rate over a certain investment horizon period.

2. Strategic/ trade buyers – move more slowly and evaluate product/market/organisational fit etc. Will base valuations on added value to their businesses, which if timing is right, might be a significant premium over market ratios, but otherwise may not be.

PE Buyers can be segmented by Enterprise Values/cheque size e.g. £15m-£30m; £30m – £60m and so on. Also, minority or majority stakes? primary investment or a bolt on? etc.

Demand

There is a huge demand for top businesses. Valuation multiples have generally increased, but to obtain the headline grabbing valuation then all aspects of the business have to be ‘gold plated and ‘bombproof’, such as 50% cagr; 100%+ net retention; market leadership; strong management team; great track record etc.

Governance

To avoid corporate governance issues, ensure the alignment of objectives across shareholders, managers and the wider company at the outset of an any exit process.

Management

It is vital to establish everyone’s attitude – staying or going etc and that the team is united during the process.

Deal Trip-ups

• Options Important to get this buttoned down tidily.Otherwise, it can be very emotive at the wrong time to be having such discussions.
• Financial Reporting competence is vital, i.e. being able provide forensic data and manipulate source data respectively. Key data points include account growth, quota performances, product segmentation, margins, cohort information etc.
• Implementation Revenues if high can be seen to be an inhibitor to scaling up and are valued typically at not much more than 1x revenue. Possible solutions were discussed with a view to mitigating this via spreading implementation costs over the life of a contract etc.
• Cash Avoid being close to running out when negotiating with a buyer (ideally have 6 months cash burn plus the elapsed time needed to sell the business e.g. 9 months = 15 months cash burn) but otherwise stress you have supportive shareholders who would provide supplementary funding if needed. Note if you go for a fund raise instead then this would take you off the market for 3 years minimum normally , before such new investors would see an acceptable return on the valuation they invested at.

Conclusions

1. Positioning early helps create positive impressions of your business in the market.
2. Important to have a strategy – or at least a framework – for an exit which should be reviewed regularly by the board.
3. A sound exit process will require a co-ordinated effort across marketing, sales, finance and operations etc, ensuring the business narrative remains consistent. An open and honest dialogue with prospective buyers at the outset is essential -they will usually identify any anomalies during the subsequent due diligence process anyway.

?IPO – Editor’s Comment

Clearly the above are wise words from an accomplished practitioner, who is representing typically selling businesses.

However, having been effectively closed to SMEs for a long time, an alternative or even intermediate phase might now be to look at an IPO. This is where:

• your company valuation is established by the public marketplace 24 x 7 – a level of transparency helpful if the business is performing but uncomfortable if not;
• public companies can be trading at a premium;
• have access to capital more readily;
• avoid shareholders back seat driving; and
• facilitate liquidity of shareholders separately from the company’s exit – all under controlled conditions.

However, to reap such benefits a valuation should be at least £50million, but preferably more than £100m to offset the costs and effort of listing in the first place and the on-going governance/reporting requirements.

Good examples are The Panoply and most recently ActiveOps, the latter chaired past and present by two ScaleUp members – John O’Connell and Sean Finnan, respectively. Either way a private sale or a public one Paddy MccGwire’s counsel applies. ScaleUp Group is proud of having such high-quality Members.