Exit strategies: When should founders sell their start-up?

The dream goes something like this: three former computer science students found a company. After investing a huge amount of time and effort into the business and overcoming many setbacks, the start-up achieves a market breakthrough and magically turns into a unicorn with a sky-high valuation overnight. The three university dropouts, who until recently had been totally broke, quickly take the company public and all become multi-millionaires. And the rest is history.

In real life, however, things don't usually pan out this way for entrepreneurs. Only a small fraction of all start-ups ever achieve unicorn status (ie start-ups valued at over one billion US dollars), and even fewer make it to the stock market. The majority of start-ups either fail and disappear into oblivion or reach a certain point and stagnate. Of course, some start-ups are ultimately acquired, but hardly any get even remotely close to achieving unicorn status. 
 

This begs the question: if the chances that a founder will hit the jackpot are slim, and there's a real possibility their company will fail at some point, when should they exit the business?

Unfortunately, there's no simple answer to that question. Why? Because it depends on a whole range of financial and personal factors, as well as the goals and intentions of any investors in the company. 

The ideal time to exit a start-up 

From a purely financial point of view, the best time to sell a company is, naturally, the moment when it can be sold for the highest amount. But thatss easier said than done, and hinges on several factors:

1. Market conditions: 
The market for start-ups must be ripe. A favourable macroeconomic environment, strong IPO market and high level of M&A activity are indicators that it is a good time to sell. The general rule of thumb is that a company should be sold towards the end of an economic upswing, when prices are high and it's easier to finance transactions. 

2. The life- and innovation cycle:
Start-ups typically want to grow and expand quickly. However, every financing round becomes  progressively capital intensive, meaning that a company in need of capital might not be able to find new investors. This is a hurdle that many start-ups aren't able to clear. Jacob Orosz, founder of an M&A boutique and author of The Art of the Exit, has the following advice: "If founders aren't convinced they can do another successful round of financing, they should sell before they run out of money." But they should also consider where a company is in the innovation cycle. If it's on the verge of launching a groundbreaking new product, it may be worth holding off on the sale in order to realise maximum value. 

3. Corporate fitness: 
To be attractive to a potential buyer, a company needs to be in good shape and ready to be sold. According to Orosz, this includes having a broad customer base, robust systems and excellent financial performance. In addition, the start-up's sales should be stable and it should have a clear growth strategy.  

4. Strong management team: 
Having a strong management team that inspires trust and credibility, and guarantees the company's stability and continuity after the exit are important aspects of corporate fitness. "Having a strong and cohesive management team is crucial. Investors don't just look at numbers, they're also interested in the team that implements the vision." says Reid Hoffman, co-founder of LinkedIn and a partner at the venture capital firm Greylock Partners.

5. Opportunity costs: 
People who sell their company will generally want to reinvest the proceeds. If there are no attractive reinvestment opportunities to be had, and founders are convinced they can further increase the value of their start-up by staying put, they may want to postpone the exit. Thomas Kristensen, Partner and Investment Manager at LGT Capital Partners, which specialises in alternative investments, recommends that founders ask themselves the following questions to better understand the opportunity costs: "How much can I currently sell my start-up for? If I wait five years to sell it, what will it be worth? And what risks and opportunities does each of these options bring with it?"

Personal considerations

In addition to strategic and financial considerations, personal factors also have an effect on the timing and type of exit.

1. Family and social life:
Building a company is demanding and can have a major impact on a founder's family and social life. Also, high stress levels and long hours can lead to health problems, so founders should do their best to ensure they remain physically and mentally fit. "When considering an exit, founders shouldn't just take the financial side of things into account. They also need to think about how it will affect their personal life", says Nadine Kammerlander, Professor of Family Business at WHU Otto Beisheim School of Management. Wanting to improve the work-life balance and support from the family can be key factors in determining the timing of an exit.

2. The financial situation: 
For many first-time founders, starting a new business means that money will be tight for quite some time, as the company isn't likely to be profitable from the outset. As a result, founders can often only afford to pay themselves a small salary at best, and sometimes no salary at all. Also, the launch of a new start-up often coincides with starting a family, which can further exacerbate a founder's financial situation. Selling equity in a financing round can help ease this kind of financial pressure. Kristensen says that a partial exit can also be an attractive option for investors. "We want founders to be motivated. Easing the pressure on their personal finances can help them focus more fully on their start-up again", he says. According to Kristensen, selling some equity after an extended lean period can be a good idea for founders - as long as they don't sell too much. 

3. Skills and motivation: 
The attributes needed to successfully build a company - such as a willingness to take risks, innovative thinking and perseverance - are not necessarily the same as those required to manage an established company. And the further along a start-up is in its lifecycle, the more important the management side of the equation becomes. Another key factor for a company's success is how passionate a founder is about the company. John Warrilow, author of "Built to Sell" and founder/CEO of "The Value Builder System", says the biggest mistake he sees at start-ups is that founders sometimes wait too long before exiting. "Typically, founders create the most value in the first five years. After that, there's an ever-increasing risk they will lose their drive and get bored", he says.
 

Investors want to have a say too

While all of these considerations are important, there is one additional but fundamental aspect that must be taken into account, namely the fact that only a very small number of founders are totally free to decide what their exit will look like. Why? Because the majority of founders rely on outside capital to start or build their company, or both. And if external investors are on board, they will want to have a say in the timing and terms of a founder's exit, and their views will not always align. 

Lisa Pallweber, Managing Partner at Austria's Hans(wo)men Group, which specialises in angel investments, illustrates this using the example of a founder who has spent years building their start-up. Despite their efforts and tying all their assets up in the company, the founder has yet to see the fruits of their hard work. "So if the founder receives an attractive offer, they will be tempted to accept it, as doing so will reduce the risk they are carrying", explains Pallweber. But an investor might see this very differently. "If they just recently invested in the company and paid a relatively high price to do so, the offer won't be attractive for them and they will want to wait until their return expectations are met before selling", she says. But the opposite can also happen, for example: a venture capital fund might be looking to exit a company towards the end of the agreed term, but because the founder wants to keep growing the company instead, they do not see eye to eye. 

Understanding each other's expectations 

It's important to remember that investors have different goals and reasons for investing. For example, angel or seed investors generally want to support start-ups long term and don't usually have a clearly defined investment horizon. Investors who participate in later financing rounds, on the other hand, usually have a clear timeline. The latter also typically want to get a higher sale price, because they paid more to invest in the company. According to Kristensen, founders should therefore make sure they understand the reason that potential new investors want to invest. He says founders should ask themselves: "Are they a seed investor or a growth investor? What's their investment horizon and what kind of a return do they expect?"

Because of these differing interests, investors will often insist on adding clauses to contracts that give them a leg up if a founder decides to exit, or that limit a founder's options. Which is why Christoph Grobbel, co-founder of the emissions-reduction company and angel investor South Pole, recommends that start-ups think carefully about why they are bringing investors on board.

He also urges them to consider the potential consequences of any clauses requested by investors, and to seek expert advice before signing any contracts. And before giving up their majority stake and voting majority, Grobbel says founders should consider the option of only partially exiting the company instead. “It can be difficult for founders who don't have a majority stake to get financing later on. The carrot may get bigger and bigger, but they often can't get any closer to it”, says Grobbel.

Founders should make sure to agree on clear exit strategies and timelines with their financing partners. However, Pallweber recommends they only start doing this during the second or third round of financing. And when having these discussions, she says founders should avoid giving the impression they want to sell as quickly as possible. "Investors want to invest in founders who think long term and who are driven by more than just financial success. They're interested in what is referred to as intrinsic motivation", explains Pallweber.