Investors and Exits

At the simplest level, investors get in (invest) in order to get out (exit). In this respect they are no different than you or me when we buy stocks and mutual funds. The big difference, however, between most investors and venture investors (and the source of the most conflict and disconnect) lies in the exit expectations. i.e. how big an exit has to be to meet their objectives.

I’m on a roadshow now helping a very successful enterprise software company raise expansion capital. This is a business that does not need VC. It could continue growing organically. But, it wants to raise it because there is a growth opportunity now. Still, towards the end of a meeting yesterday a VC asked “do you really want my money?”.

What he meant by that is not that he’s a nasty SOB. Instead he wanted to know if the founders were ready to sign up for the VC game and work to deliver an exit that would meet the VC’s objectives.

When you own all or most of your company an exit of a few million can change your lifestyle forever. But as soon as you bring in VC$ the threshold for exit relevance goes up.

Let’s say you sell 20% of your business for $ 2M. If that investor wants a 10X return (yes, this still comes up every time I pitch), they are looking to get $20M back on exit. If they own 20%, then you need to exit for $ 100M ($20M / 20%). That’s a high number.

If someone were to show up today offering you $20M for your business, you might want to take it. After all, that’s $ 16M split between the founders, angels and employees. But your VC would only get $ 4M or 2x its capital. In many cases, they would block this sale (and yes, they almost always have this blocking right).

So, before raising VC or trying to raise VC, ask yourself:

- How big can this be?
- How big do I want it to be?
- How much capital do I think it would take to get there?

There are many more questions, but these are the basics. Where most startups fall short (and hence get rejected) with VCs is not that they are bad businesses. They just are not likely to be big enough to deliver big returns.

So, try and size the opportunity before you begin fundraising and decide if this an angel size opportunity or VC one. Your capital raising and spending strategy will be driven by this exercise. i.e. if you don’t see a $100M exit in the future, don’t go down a burn path that is going to require raising VC. It might not be there when you need it. Keep the burn low, keep capital requirements low. You can always double down and change your strategy later.

To me, there is absolutely nothing wrong with not wanting to build a $100M exit. Only a small portion of businesses and entrepreneurs fit this profile. But VCs (especially the bigger ones) will always assess you through this lense. This is why they invest in less than 1% of the company’s they see.

Size your opportunity and ask yourself if you’re really up for the VC game before you pitch. And always remember what type of exit they want.