Just about every week I get a call from an entrepreneur trying to decide whether to raise another round of capital for his or her company, or sell the company and get out while the going is good. It’s usually an emotionally-charged discussion. There are all kinds of personal considerations that go into that decision, as well as the fiduciary responsibilities to shareholders and employees.
The purpose of this piece is to help entrepreneurs approach the decision dispassionately, by looking at some industry benchmarks and doing the math.
Consider the following chart. Each round of funding will dilute the founders between 20% and 30%. The more money the company raises, the less ownership the founders will have at exit. Each raise needs to increase the value of the company commensurately. This is where the math often falls apart.
Last year I was asked to look at selling a VC-backed company that had raised $10M. The comps and multiples for the deal in the market would support an acquisition price between $12M and $20M, depending upon whether I could attract a financial buyer or strategic buyer. But in any case, after the preferred stock holders (the investors) got their liquidation preferences, there would be little money left over for the founders. This was a no-win for both the VC’s and the founders, based on the kinds of returns VC’s need. The company decided not to sell, but to keep slugging it out in the market and try to raise more money. It hasn’t gone too well and will likely be a total loss.
Conversely, I was recently asked to look at selling a company that had grown revenues 200% in each of the last three years. They have had some seed funding from angels, but no VC funding. The VC’s had now come knocking. It didn’t look like the company would have a problem raising capital if they wanted it. After much debate, the founders decided to sell to one of the bigger players in the space who had also come knocking. I honestly told them I didn’t think I could get much more for it than what they were being offered. They were happy and both walked away newly-minted millionaires after paying off their seed investors.
According to several sources I consulted for this piece, the median level of founder ownership at exit is 11%. The average is slightly higher at 17%. This is consistent with my own experience as a venture-backed entrepreneur.
In most of my deals, my ownership stakes at exit were slightly less than 20%. In each case, my co-founders and investors decided to swing for the fences. We were shooting for $100M+ exits. A 20% stake of a $100M exit is just fine, thank you very much. None of them turned out to be that big. Had we sold earlier and taken less VC money, the founders would have walked away considerably richer.
In his book, Early Exits, Basil Peters points to many examples where selling earlier was far more lucrative to founders and investors than raising capital and waiting longer, hoping for a bigger payout. Just check Forbes and Inc. for stories about founders who made millions on selling their companies for less than $10M – and those that made ZERO after selling their companies for $200M. Go figure.
So, here’s the top-level analysis entrepreneurs of growing companies need to do. Some of it is subjective; most of it is math:
1. What is the company worth if I sold it today, without taking any additional investment capital?
2. How much do I own and how much would I walk away with today, after selling fees, legal fees, taxes, and distributions to the other shareholders?
3. What is the likelihood and time frame for raising additional capital in the current market and what would I have to give up for that additional capital?
Side Note: raising capital is time consuming and will take you away from building the business, so another risk factor to weigh is the impact on the business to raise versus sell.
4. Would that additional capital all but ensure my ability to increase revenues and earnings to fetch a higher valuation than what I would get today, commensurate with the amount of ownership I would be giving up?
5. Assuming I take the capital and execute reasonably well, what is my valuation likely to be in 3-4 years?
Side Note: A good benchmark is a multiple of EBITDA. The larger the company and the better its performance, the higher the multiple. The vast majority of deals I work on are in the lower-middle-market and in the 3x to 5x range.
6. Am I in a growth market, with a unique and sustainable position that all but ensures I won’t be displaced by our competitors or by a new entrant, if I keep playing the game?
To be clear, I never advocate for one decision or the other. I am an investor in several startups and I want them to swing for the fences, not sell too early. It’s a personal decision for each entrepreneur, depending upon their objectives and circumstances, but one that should be made after a fair and dispassionate analysis. It’s not how much the business is worth, or could be worth, that matters. It’s how much you get to walk away with to start your next chapter. Here’s to your successful exit!