The Fundamentals of Talking "Exit Strategy" with Investors

At the seed stage, talking about exit strategy always seems a bit premature, even presumptuous. But this topic is always in the back of mind for VCs and other investors, so it’s important to formulate a plan around the topic, even if those exit strategies might change as you grow your startup. 

Investors are giving you capital to make 10x, 20x, or 100x their investment. To realize this, there must be an exit. For this reason, it would be ridiculous for a founder to ever tell a venture investor that they want to keep the company private. But it’s also not smart to go into a meeting having just achieved product-market fit and tell an investor that you plan to IPO. The exit strategy conversation should be nuanced, and founders should use it as a way to show investors you can think about things from different angles. 

The definition of Exit Strategy from Investopedia: “The method by which a venture capitalist or business owner intends to get out of an investment that he or she has made in the past. In other words, the exit strategy is a way of “cashing out” an investment.”

Investors ask about exit strategy as a way to gauge your abilities as a founder, not to seriously consider planning for an immediate exit. Here’s why investors typically ask about exit strategy: 

  • They want to gauge your level of commitment to building the business and realizing a large, venture-backable vision for the business. 

  • They want to understand your level of flexibility and your ability to weigh different situations when thinking about risk and return. 

  • They want to know if you have thought about possible exit scenarios to gauge whether you are capable of imagining different scenarios and have a grasp of the business landscape in which you are operating. 

The most common (yet still difficult to achieve) startup exits: 

  • IPO: When a company has significant, predictable revenue, has become a major player in their industry, has strong business processes in place, and has a low debt-to-equity ratio, the time is right for an IPO. 

  • Acquisitions: When a larger company has an immediate need for your product or technology and it is difficult or impossible for them to build that product in house, then you may have an opportunity to exit via M&A. 

Dreamit Managing Partner Steve Barsh talks about how early-stage startups and their founders should avoid discussion exit strategy with investors and why it's important to paint a powerful vision for VCs about how you're going to dominate your market and grow a big, powerful, profitable, and meaningful company.

Here are some topics for early-stage founders to consider when discussing exit strategy with investors: 

  • Don’t tell investors that you have definite plans on being acquired by a large, well-known corporation. In reality, exits are an outcome, not a strategy. Often, acquisitions by large corporates are matters of luck and timing, rather than the result of careful planning on the part of the founder. Take Google as an example. Companies like Google are making acquisitions when they need to fill a critical gap in technology and see an opportunity (i.e. a startup) that fills that gap and has the ability to scale quickly with the resources that a company like Google can provide. If Google has already made acquisitions to fill critical needs, it may indicate that it’s less likely rather than more likely to do so again in the future. Around 2012, Google made a large number of acquisitions of smaller companies, but years later those companies were shuttered or open-sourced, and the pace of acquisitions fell. Investors realize that acquisitions are market-dependent, so providing comparables are often taken with a grain of salt in the exit strategy conversation.

  • Don’t overplay your discussion of exit strategy. Some investors are irked when founders talk about exit strategy because it implies that the founder knows what will happen in the future. In these types of situations, it’s best to focus on the vision for your startup and keep your exit strategy in your back pocket in case the question comes up. 

  • Even if you discuss exit strategies with a VC, it’s always best to convey your enthusiasm about building a company to a dominant size in your market and to convince the investor that you have the personal drive to disrupt the industry you are tackling. Some founders convey the message that they are building the company for a quick exit. This is risky. A writer in hacker news succinctly described the elements of this gamble: “1) An acquirer exists 2) The acquirer has a reason for wanting to acquire the company 3) The acquirer has the money to do so 4) The deal will actually close without being scuttled during negotiations by one of the parties (or the startup's VC's) 5) 1-4 will happen before the next tech crash 6) As a founder, you will still have enough equity at the time of (5) for all of it to be financially worthwhile. If any of 1-5 goes wrong, you'll be left without a chair when the music stops.”

  • Avoid bringing up conversations with corp dev teams if you have had those discussions. If you’re an early-stage founder, you should probably not be speaking to corp dev teams at all. These conversations should start when you are actively looking to exit (Paul Graham has a great essay on this topic). If you tell potential investors you are actively speaking to corp dev teams, they’ll wonder why you aren’t focusing on building your product or bringing on new customers. It’s also a signal that you have doubts about whether you can build the company into something great.

In short, you have to walk a fine line as a founder when discussing exit strategy. Say enough so that VCs understand you are flexible and understand the market dynamics of the industry, but don’t scare investors away by giving off the impression that you’re building this company to sell it off. You want to find investors that are captivated by your mission and will invest time and energy in helping you, not just investing capital. Sell the idea that your startup is going to change the world. This should be an easy sell if you believe in your own vision. 

Written by Charles LaCalle (@charleslacalle)
Dreamit Ventures