David Ehrenberg is the founder and CEO of Early Growth Financial Services, an outsourced financial services firm that provides early-stage companies with day-to-day transactional accounting, CFO service, tax, and valuation services and support. He's a financial expert and startup mentor whose passion is helping businesses focus on what they do best. Follow David @EarlyGrowthFS.
It might seem strange to consider exiting when you're just starting up and preoccupied with assembling a team and getting funded. But thinking through, planning for and working toward an eventual exit is something every entrepreneur needs to do.
Why is having a startup exit strategy important?
Your end goal affects everything from how you run your business, to the partnerships you pursue, to how you choose to fund your startup. By thinking and planning ahead, you're much more likely to be prepared when you do exit--whether that's in 18 months or 10 years down the road.
Keep reading for an overview of what you should be thinking of even from the earliest days of your startup, depending on your end goal.
If your ideal exit is through an IPO, start with the end in mind. First, keep in mind that only a tiny minority of startups exit that way. Then structure your business so that you avoid obvious obstacles to your goal of an IPO. That means:
- Choose an IPO-friendly business entity. Institutional investors prefer Delaware C-Corps.
- Put a cofounder agreement in place. Not only should this delineate who is responsible for what, but it should also outline what happens to shares if one of you leaves prematurely, whether voluntarily or involuntarily.
- Lock down your IP. Document your ownership, get acknowledgements and signed agreements from employees and contractors as to ownership, and make sure what you own is protected by copyright, trademarks and/or patents as necessary.
Then, as they say, go big or go home. Concentrate your energies on a product/service and customer segment that will generate large numbers of users and rapid growth.
Creating a Lifestyle Business
In this model, of which Tim Ferriss is probably the highest profile proponent, once your business reaches your desired scale, you live off the cash flow with or without tons of hands-on involvement. In that case, you might set up as an LLC or as an S-Corp to minimize your taxes. You should also:
- Don't spend lots of cash on development. Capital intensive businesses, whether driven by software development or product manufacturing costs, take longer to become profitable. Look for areas and services in which you can generate recurring cash flow while minimizing overhead and startup investment.
- Bootstrap, take out loans, and tap angels for capital. Since you're not setting up for huge growth or market disruption and your eventual exit is likely to be modest (at least in terms of VC expectations of 10x returns), you'll neither want nor be likely to attract institutional investors.
Maybe you have your eye on being Google's or Facebook's next acquisition at a rich multiple. If so, you need to:
- Make sure you aren't a "me too" player. It can be hard to overcome first mover advantage (look at Lyft). Focus on filling an unaddressed market need and owning your product niche.
- Invest in your team. Many acquisitions are driven as much by the desire to lock up scarce talent as they are by acquirers wanting to get their hands on a killer product. Make sure you recruit A-players who produce tangible value as a team.
- Be careful when entering into business partnerships and/or significant contracts. Make sure any partnership or contractual agreements you enter into include options for early termination and/or the ability to assign them to a successor entity.
- Keep your capital structure simple. While most exits are through acquisition and not IPO, make sure any investors you take on understand and buy into your strategy and that there are no minority investors in a position to throw a wrench into a deal. Also, avoid including lots of small investors in your capital structure.
As you can see, there's no one right answer. But you should define what success looks like for you. And if you plan to take on outside investors, they will expect you to be able to clearly spell out your path to an eventual exit, the milestones you need to hit, over what timeframe, and your anticipated valuation at exit. They'll also expect you to produce data points to back these up.