Adapted from Bo Burlingham's Finish Big, available now.
When Basil Peters was 40 years old, he received his first lesson in exits: his own. He hadn't been expecting it and didn't want it, but he had no choice. The company he had co-founded 10 years earlier, Nexus Engineering, had grown into the second-largest manufacturer of the headend equipment essential to all cable television systems. Then, in 1989, the collapse of the junk bond market deprived Nexus's customers, the major cable companies, of the capital they had depended on, and they stopped paying their bills.
It took a year and a half for the situation to become dire. By 1991, Nexus was in trouble with its lenders, and bankruptcy loomed. Peters was so focused on his search for an acquirer that he failed to notice one of his venture capital investors had launched a quiet campaign to round up board votes for a hostile takeover. The VC firm's plan was to thwart a sale and instead do a "washout round" of financing that would leave it in complete control and render worthless the stock owned by the founders and early investors. Peters was soon in a drag-out fight to get Nexus's board and shareholders to approve a sale to the company's largest competitor, Scientific Atlanta. Had he failed, he would have lost everything he'd spent the previous 10 years working toward. He ultimately won by the slimmest of margins, though he had to settle for a price far below what the company would have commanded had he educated himself about the exit process before the crisis struck.
But that was then.
Now, more than two decades later, he stands in front of 60 entrepreneurs, investors, and business advisers in a packed lecture room in downtown Vancouver, British Columbia. They've traveled from all over North America for a daylong seminar on exit strategies, starring Peters. He is delivering a message you might be surprised to hear if all you knew about him was the story of his own first exit.
"I believe exits are the best part of being an entrepreneur or investor," he says. "It's when we get paid for all of our hard work and risk capital. But it's also the least understood part. Many of the things we believed about it just five or 10 years ago no longer apply. The good news is that, if you're thinking about selling anytime soon, your timing is excellent."
Over the past five years, Peters has emerged as a leading figure in the world of business exits; he is known as a champion of what he calls "early exits." By that, he means exits that happen much earlier in the life of a business than has been the practice in the past. Peters has written a book on the subject, and when he isn't working with clients of his boutique M&A firm, Strategic Exits, he can be found spreading the word about early exits. They are, he admits, his obsession, and he wants to help as many people profit from them as possible.
"This is a golden age for entrepreneurs, and especially technology entrepreneurs," he says. "I've been one for my whole life, and I've never seen a time when it's so easy for technology entrepreneurs to start companies on very little capital, grow them very quickly, and exit them just a few years from startup."
And he isn't talking just about the headline-grabbing early exits, such as at Instagram and Skype, which were bothsold for more than a billion dollars after less than three years in business. "They distort our perception of what's going on," he says. "The big story in entrepreneurship today is not the small number of big exits but the much larger number of small exits. There are many, many entrepreneurs quietly starting companies, selling them after a few years, and putting $10 million or $15 million in their bank accounts." How many? The total number is hard to come by, because many private-company acquisitions are not reported. Joel Wiggins, the president of Crown College in Saint Bonifacius, Minnesota, estimates that the average is about 10,000 per year over the past nine years. (See sidebar on page 122.) Whatever the actual number, Peters is correct that the vast majority are relatively small. Rob Wiltbank, entrepreneurship professor at Willamette University in Salem, Oregon, notes that the median price of private companies acquired by public companies is just $14.8 million. That median would undoubtedly be even lower if private-by-private acquisitions were included.
But Peters's focus is not so much on the number or the price as it is on the time it takes companies--especially technology companies--to become sellable. That period has been rapidly shrinking, he says, because of two developments in the past 20 years or so. The first, of course, is the internet, which has given birth to companies capable of growing at a rate otherwise unimaginable. The second has to do with the changing appetites of some large companies, which have concluded that they're not very good at innovating but have the resources to take an existing line of business and scale it rapidly. Accordingly, they've cut back on doing their own research and development and instead buy startups, in effect outsourcing a portion of their R&D.
Peters wasn't the first to notice either of these developments, but he was well ahead of anyone else in drawing attention to the opportunity they've created for entrepreneurs and angel investors. His experience as an investor led him to his discovery.
He'd started investing in promising companies after the sale of Nexus. "I watched them become valuable, then keep on going without exiting, then become a tax write-off," he says. "It happened quite a few times before I learned the lesson, at great expense, that there are two parts to successful investing. You have to buy right, but it's equally important to sell right. You have to exit at the right time and in the right way." One example he often cites is Parasun Technologies, a Canadian supplier of private-label broadband services to independent cable television operators throughout North America.
Parasun was still in startup mode when Peters first visited. It had taken almost three years for the company's founder and principal owner, Barry Carlson, to figure out what business he should be in. A cable television business had asked his company, then called ParaLynx Internet, for help in providing broadband service to its customers. Carlson realized he could do the same for the other 4,000 or so independent cable television operators in North America. So Parasun was born.
In the small world of Vancouver entrepreneurship, it wasn't long before Peters heard about Parasun. He asked for an introduction from a colleague, attorney David Raffa, who sat on Parasun's board, and then visited the company. He liked what he saw. "It was one of those classic kinds of startups, where you walk in and immediately get the sense of being in an exciting, early-stage company," he says.
By then, Parasun had 35 shareholders, including 11 employees, and Carlson, among others, was interested in an early exit. Peters said he would work with Raffa on a sale provided he could come in as an investor with a mandate to find a buyer, and manage the process as he and Raffa saw fit. As part of the deal, Peters would replace Carlson as chairman of the board.
It took three years to complete the sale. The first step was to get everyone aligned around a common goal. Peters, Raffa, and the managers felt that the company would be worth a lot more if they continued building it for a few more years. The early shareholders, however, wanted liquidity as soon as possible. To keep them happy, Peters and Raffa arranged a secondary offering that allowed them to cash in some of their stock. That paved the way for an off-site meeting, in September 2005, at which all of the key players agreed on an exit plan: to sell Parasun within two years for at least $10 million.
Next, Peters and Raffa had to get the company in shape to be sold. The biggest challenge was the inexperience of the management team. "While they were doing a good job, they still had a lot to learn," Peters says. "For the better part of a year, I'd meet with them once a week to focus on some critical aspect of the operations."
He calls these "mentoring sessions," but the other participants had a more jaundiced view. "Basil drove everybody with absolutely mindless determination," Carlson says. "He said, 'We have to hit our numbers every month. That's how we'll get the best dollar for this business.' He ruffled feathers. But, dammit, it worked, and everybody did well as a consequence. The people who went through it will tell you now that they are grateful to him, very grateful."
Operations aside, Peters had a checklist of more than 50 other things--from hiring an audit firm to assembling a "deal book"--that had to be done before Parasun was put on the market. By the late spring of 2006, the tasks were completed, and the company was projecting $12 million in sales in the coming year, up from $8 million the year before, with EBITDA (earnings before interest, taxes, depreciation, and amortization) of $2.2 million, up from $1.5 million. Peters and Raffa decided those numbers would allow them to hit their $10 million target price, and moved to the next stage.
First, they identified about a hundred potential acquirers and contacted each one. Seven or eight candidates wound up signing nondisclosure agreements that allowed them access to the financials. Out of that group, three prospects submitted offers--enough, Peters says, for "a pretty active auction."
"It was a real education for me," Carlson says. "At one point, we had an offer I was content with, but Basil and David said, 'Let's keep the working capital.' " This meant hanging onto a seven-figure bank account that Carlson assumed was automatically part of the sale. "So they went back and said, 'OK, we like the numbers, but we're going to keep all but a quarter of a million dollars in working capital.' The buyer said OK. That was an extra $1.6 million I would have left on the table."
The winner was publicly owned Uniserve Communications Corp., which bought Parasun in May 2007 for an announced price of $12.5 million. But after the working capital was added back and other adjustments were made, the final proceeds came to $14.8 million, just shy of 50 percent more than the $10 million target that the Parasun shareholders had agreed to in 2005.
In selling Parasun, Carlson avoided a crucial mistake that Peters estimates is made by 75 percent of business owners. He calls it "riding the value over the top," that is, missing a window during which a company's value is peaking. It typically happens because owners don't have an exit strategy and therefore aren't prepared when a good selling opportunity comes along. In many cases, they don't even recognize the opportunity. Peters himself is a prime example. Only in retrospect did he realize that he'd missed a chance to sell Nexus for a lot more money. "We were growth junkies," he says. "We wanted to start companies and grow them faster. Selling one had never occurred to us, which I now find amazing. I just can't believe we didn't have an exit strategy. We'd never even discussed it. It was one of the worst mistakes of my career."
Even if you have thought about exiting, you're still going to need a guide through the process. Selling a business requires expertise that most business owners don't have, mainly because they've never done it. But getting good advice presents challenges of its own. Peters contends that the business world is rife with misinformation about exits, and he has made it his mission to set people straight.
Back in the Vancouver lecture room, he is trying to do just that. There are many myths, he says, that prevent entrepreneurs from realizing the full value of the businesses they've created. He points to the common wisdom that, before a business can be sold, it must be profitable or must have grown to a certain size. "That's simply not true," he says. "The real threshold is to prove the business model."
He gives the example of a recurring-revenue business, such as a company that sells subscriptions to some type of service. The model is proven, he says, when the owners can document 1) gross margin per customer, 2) the length of time a customer remains a customer, and 3) the cost of customer acquisition. "In other words, how much a customer is worth and how much it costs to acquire one," he explains. "And actual data, not projections." The idea, Peters says, is to be able to project credibly how much the business would be worth if an acquirer invested a given amount of capital.
Peters further argues that owners should seriously consider selling such a business as soon as the model has been proven. "It's always best to sell on an upward trend," he says. "You sell on the promise, not the reality."
That's no doubt good advice, though it's not of much use to entrepreneurs more interested in building to last than executing a quick sale. Peters has attracted his share of critics who accuse him of promoting the gold rush mentality that took hold of Silicon Valley during the dot-com bubble of the late 1990s. "Built to flip" is the term that Good to Great author Jim Collins used to describe the strategy in a famous essay he wrote for Fast Company in March 2000.
Peters bridles at the criticism, contending that the companies Collins wrote about with Jerry Porras in Built to Last--such as Disney and Walmart--"are not the type of companies that can be started, thrive, and prosper in the 21st century. It's just not possible to take decades to build a company anymore." His argument seems questionable at best. After all, plenty of entrepreneurs are still striving to build great companies both on and off the internet and taking decades to do it. Amazon, Google, and Starbucks come to mind. That said, even Collins agrees that there's nothing inherently wrong with planning for an early exit. He acknowledged in his essay that "building to last is not for everyone or for every company--nor should it be."
So is this really a golden age for entrepreneurs? We probably won't know for sure until it's well behind us. What we do know is we're heading into a period when exits are going to be very much on the minds of hundreds of thousands of business owners, especially aging baby boomers. Its members are now moving into their 60s and 70s. One firm, SME Research, estimated in 2012 that, as a result, 1.36 million to two million companies would be for sale in the next five to 10 years.
Right now, Peters says, it's a seller's market, mainly because big companies and private equity firms have more cash than they know what to do with. As it is, just 20 percent of companies being put up for sale are sold, according to a study by the U.S. Chamber of Commerce. But as more baby boomers try to sell their companies, the market may get crowded and selling could become more difficult.
From that perspective, the work that Peters and others are doing to educate people about exits is more important than ever. The fact is that if you have not yet begun thinking seriously about your exit, you're taking an enormous risk. "I bungled my own first exit, and I watched several of my contemporaries bungle theirs," says Peters. "Many entrepreneurs have invested their lives in the companies they've started. To wind up with little or nothing to show for it is really heartbreaking."
Fortunately, it's also unnecessary.
Adapted from Finish Big, by Bo Burlingham, published by Portfolio, a member of Penguin Group (USA). Copyright 2014 by Bo Burlingham.
What About Going Public?
In 2013, only 222 companies went public in the U.S., while more than 9,000 were acquired. That's fewer than one IPO in 40 exits. Why such a lopsided ratio? That's what I asked 90 founders who sold their companies for between $50 million and $500 million. All of them had the option of going public, but chose not to. They cited a variety of reasons:
- Too crowded. Some felt there was no room for another public company in their part of the market. Either the segment was too small or it was already dominated by a few large companies.
- Too narrow. Some saw that other public companies built around one product were less likely to succeed.
- Too complicated. Many founders were reluctant to shoulder the regulatory burdens of becoming a public company.
But mainly, founders felt that a sale to a strategic buyer was a more secure path than an IPO. For one thing, IPOs can be tricky. A lot can go wrong. Will the offering be properly underwritten? Will it attract enough investors?
Management risk is another factor. To succeed as a public company, you need managers with public company experience, and many businesses don't have them. But hiring them is expensive, and they may not work out. So don't be surprised if a sale to a strategic buyer seems like a safer bet. --Joel Wiggins