Raise capital or sell the business? – What’s the right thing to do, why, how and when?
I meet a lot of entrepreneurs running tech companies where they are struggling with this important decision. Especially where the founders and shareholders have different motivations and expectations that have evolved during the journey of building the business and attracting investors.
For a first time entrepreneur, selling-out and cashing in to secure a personal financial future is fully understandable. For an investor, it might be the absolute wrong thing to do, if the aim is to get a 10X return on the investment in the next 5-8 years. But it could also be the right thing to do for an investor if a strategic buyer comes along offering a price way above market valuation, delivering the return on capital sought. It could also make sense to sell if the market conditions have changed significantly since the original investment was made, and the opportunity/risk profile is such that the best route is now to sell.
Misalignment between founders and investors on the exit timing and outcome seems not unusual, especially with angel and seed-investment where no liquidation preferences are defined, and everyone pretty much have the same class of shares. Then it simply comes down to the shareholder agreement and how many shareholders agree to sell and “drag-along” the rest.
With VC investments that carry liquidation preferences, it’s paramount for founders to understand the investment terms and sketch out the scenarios of future absolute returns in hard dollars for various exit valuations.
With series A-round requirements becoming more and more challenging, exiting before inviting an institutional investor with higher expectations of exists, can be very attractive for a founder team who still owns a majority of shares in their company and no previous exit to fall back on.
The question of selling or taking in more money is of course not just for fast growing tech companies, but its also true for businesses that might have matured, making a profit but also reaching a point where something’s got to happen or else stagnation will set in. And we all know that slowing growth and flat revenues in the tech world mean fast erosion of enterprise value and the risk of key staff defecting to competition.
Successful IPOs on any major public market are today reserved for a few tech companies reaching a typical minimum of $100MM+ in ARR (Annual Recurring Revenues) and 30-50%+ growth trajectory, often turning into so called unicorns ($1Bn+ valued companies) even before going public. This leaves most companies’ only real attractive exit opportunity to be acquired by a strategic buyer for cash and/or stock.
Sometimes the option is selling out to a Private Equity (PE) fund who is “rolling-up” a group of companies in a particular market sector to create a bigger entity with critical mass for later IPO or tradesale. The PE consideration is typically lower than a strategic buyer would pay, but also offers an up-side in some of the payment being stock in the combined entity.
Taking in new round of capital to fuel further growth requires a lot of effort on behalf of the CEO, who at the same time is supposed run a growth business. Following the investment, the pressure is of course now on the CEO and founders to continue to build the business, raising the bar to achieve an even higher enterprise valuation (e.g. 10X of the post-money valuation). Again, anything less will dilute the founders share in future exists as any Liquidation Preferences kicks in, not to mention the dilution that the investment round itself created for the founders.
In any event, fundraising, IPO or tradesale, the road to a successful exit requires a consensus between the founders, the board and the major shareholders of what creates the best outcome for everyone concerned.
But even if this is agreed at the time of investment, things always change as the company and its market evolves in ways no one would have been able to foresee. The pressure is always on the founder/CEO-team to adapt to new circumstances, new competitors, investment sentiments and valuations. The leadership team must consider pivots, re-tool, re-strategize, re-group, persevere and keep moving forward to win new customers, whilst manage cash-flow, improve products/services and motivating the organization to stay on course.
What I often see happening in this venture-journey is a kind of dis-connect between investors (and passive shareholders), and the people actually running the business. Especially founders who have been there from the start who feel that their investors don’t really understand their world and reality of eating, sleeping, running the business 24/7.
A topic not so often discussed is the sheer fatigue and stress that many founder CEOs experience after years of putting in 16-hour-days, including weekends and cancelled vacations. The attraction of an exit for founders/CEOs grows as the pressure mounts over many years, especially if the original business strategy has changed, sales are not reaching the plan and cash-flow problems is on top of the “do-list” every day.
This high pressure entrepreneurial lifestyle of founders/CEOs often results in broken up relationships at home and health problems, sometimes even including depression. It’s not a topic that is discussed too much as the venture world expects its entrepreneurial heroes to “stand the heat or get our of the kitchen”. So it’s no wonder that many struggling first time founders are inclined to wanting to sell the business maybe well before the optimal enterprise value has been reached, creating tension with investors, unless both sides of the table are open and honest about what is best for all parties involved.
If investors don’t pick up on these signs of “founder fatigue”, then their investment is likely to suffer, and alignment is lost between the people running the company and the ones having put in money to get a return. So even if the company has great potential for further growth, and the funding is available, the founder/CEO might not have the stamina to stay the course.
At the same time, the CEO and the leadership team who are dealing with market challenges every day, might be right that the time for a trade sale is actually now, before the company becomes irrelevant and loses its competitive edge. Investors might not want to hear this and only sees this as a reason to find a new CEO as the founder has simply not “got what it takes”.
It’s therefore important for the board and investors to have an open and frequent communication with the founders and CEO teams to consider both the personal aspirations, motivations and level of “belief” in that the company will indeed reach its goals.
The following are some practical suggestions for both founders, CEOs and board members to consider on the topic of timing of exist versus raising new funds – at the start of the investment, bi-annualy or when threes a game changing market event
- Founders to align with investors the idea of what a good outcome actually is, and when
- Share views of market conditions and the opportunity/risk of reaching the agreed outcome – at each board meeting
- If you raise money from investors and especially VCs, understand the terms, especially liquidation preferences and VCs expected return on capital
- Founders to explore ways to achieve “mini-exit” at time of capital raise to take some of the personal cash-needs out of the equation
- Always develop strategic partnerships with companies that you feel could become natural suitors – it’s better to be bought than to try to get sold
- Consider dual-track when fund raising, to test the tradesale path with strategic investors-cum-buyers, looking to pay over the odds for your tech to fill a product/service gap
- Don’t say no to decent acquisition offers – many times companies have walked away from deals that never return again
- Consider deals with Private Equity firms where part of the consideration is cash and part is “up-side” stock of the new combined entity
In conclusion, if there is one key advise on the subject of raising capital or selling the business I would make, it’s to make sure both founders, CEO and larger shareholders share the view of the outcome’s opportunity and risks, and that the people running the business every day are totally passionately 110% motivated!
What are your thoughts and experiences – Looking forward to hearing from you.
If you want to discuss these topics and your particular situation, please feel free to contact me for a chat.
Happy growth trails towards your desired outcome!