Plan for the exit when you start your company

The following was originally published by the Idaho Business Review on June 15, 2015.

Everyone who starts a company will need an exit one day. No one can work forever; at some time you will want to (or have to) retire and/or your investors will want to sell their stock.  An exit is how you monetize the value you have created in your company. You can either be intentional and plan for the exit, or unintentional, and likely not have a satisfactory transition out of the business. 

I have a friend who is a dentist.  He spent years building his practice and he made a good living from it. He consulted with advisors and built an exit plan. When it was time to retire, he sold his practice to another dentist. The acquiring dentist purchased the building, the equipment, the patient list and the reputation of the clinic.  The sale turned the value of my friend’s practice into cash he could use to fund his retirement. Without that sale, he had no way to monetize the value he had created. Worse, he might have been stuck with a specialized building and depreciating dental equipment. 

Angels invest in companies specifically designed for an exit. They expect the company to be acquired by another company. This is the way the companies create liquidity for their investors. 

I’ve just returned from attending the annual meeting of the Northwest Chapter of the Angel Capital Association where I attended a exit strategy seminar with Dr. Basil Peters.  Peters is a recognized expert on the subject, and is the author of the book Early Exits: Exit Strategies for Entrepreneurs and Angels.

According to Peters only 25% of saleable companies successfully exit.  Another 25% exit, but for less than might have been obtained.  And 50% of those companies could exit fail to do so; that is they fail to find a buyer and have to continue to operate, frequently in an increasingly competitive environment.  Many of them ultimately fail. 

Peters make a number of recommendations to improve the possibility of a successful exit. While he is writing specifically for angels, his advice is also applicable to cash flow type businesses. 

1.     Every company should develop an exit strategy at the time of its founding, not years later.  Company management should be intentional about how and when they intend to exit. For example, an exit strategy may be as simple as “Our exit strategy is to sell the company in about ___ years for around $___million.”  My experience is most entrepreneurs have a very vague strategy along the lines of “someday we will be acquired.” 

2.     Make sure the management and the investors stay focused on the exit strategy by making it the first item on the board agenda at every board meeting.  The board should begin its meeting discussing the exit strategy to be sure the company remains focused on the end game.

3.     Recognize that companies are sold, not bought.  Most people don’t wait for an unknown buyer to knock on the door of their home asking to buy it. When it’s time to sell it, they develop and execute a strategy.  Yet many entrepreneurs seem to be waiting until someone discovers them and makes an unsolicited offer.  Research shows unsolicited offers usually result in sub-optimal results, as it’s hard then to develop a plan to approach multiple possible buyers.

4.     Engage an investment banker to help you bring the company to the market.  Just as most of us engage a real estate broker to sell our homes, a banker knowledgeable in mergers and acquisitions in your industry will help you package the business, identify companies that should be interested, and approach them. The purpose is to try to create an auction market among multiple buyers.

5.     Understand the threshold for selling an early-stage company is not based upon size or profitability.  It’s based upon proving the business model.  When management can reliably show it knows how to acquire customers that produce a margin, at a cost of less than the lifetime value of the customer, then it is ready to be sold to a company with the resources to grow the company rapidly.

My experience as an angel investor suggests to me that most companies are not nearly as intentional about the exit as they might be.  For both companies built for cash flow and for those built for exit, be intentional about the exit.  Have an exit plan, and let the plan inform the day-to-day decisions.

Job Creation, Angels and Entrepreneurs

We know from US Census data that newly formed businesses are the prime job creators in the US Economy.  The Kaufman Foundation recently released a new study that confirms this fact (“The Importance of Young Firms for Economic Growth,” Kauffman Foundation Entrepreneurship Policy Digest, September 25, 2014).  They concluded “New businesses account for nearly all net new job creation…”  Read the report here.

Here are the data.  The blue line is the net job creation by young firms.  The red and yellow lines are net job creation by companies six years old and older. At best, the net new job creation by older companies is zero, and in some years, less than zero.

The implication of these data is that one of the most important steps a community interested in economic growth can take is to create a robust entrepreneurial ecosystem.  One facet of that ecosystem is the availability of risk capital for early-stage growth businesses.  Angels typically provide that capital.

Some Boise angels have been investing together for nearly eight years through “angel funds.”  Angel funds are companies formed for the specific purpose of making early-stage investments.  Three have been formed in the Treasure Valley.  Collectively they have invested $2 million in 20 local companies.

One measure of impact is job creation.  As of December 31, 2014 these 20 companies have created 330 jobs since we made our investments.  This is a significant positive impact on our economy. If, for example, the jobs created averaged only $30,000 per year (I suspect, but don’t know that it is much higher), that’s an annual impact in the Treasure Valley of nearly $10 million, not counting multiplier effects. 

Also important are the sales of these companies.  In 2014 the total sales of all companies in the portfolios was approximately $185 million. 

Improving the entrepreneurial ecosystem is not a quick fix.  It takes time to have an impact. Here’s a table of the jobs created by these companies:

Year    Cumulative

            Jobs Created

2010               25

2011               66

2012               109

2013               208

2014               330                       

It's clear to me.  If you want to create more jobs, increase the number of start-ups.  One roadblock to doing this is capital.  We don't have enough early-stage capital in Idaho.  

A number of dedicated folks are working to increase the capital available. Jessica Whiting of Startup Grind arranged for Scott Kupor, Managing Partner of renowned Silicon Valley venture capital firm Andreesson Horowitz to come to Boise in early March, 2015.  Brad Bertoch, CEO of Salt Lake-based Wayne Brown Institute has brought its programs to Idaho to help connect Idaho companies to Utah angels and venture capitalists.  And the Idaho Technology Council has had an initiative almost since its founding to increase investment capital in the state.

While all these efforts are good and much appreciated, there is a simple public policy step that would directly impact the availability of startup capital. That step is to give a state income tax credit for equity investments in startup companies. At least 18 states and all of Canada does so.

For example, "Minnesota's Angel Tax Credit provides a 25-percent credit to investors or investment funds that put money into startup companies focused on high technology, new proprietary technology, or a new proprietary product, process or service in specified fields. The maximum credit is $125,000 per person, per year ($250,000 if filing jointly). The credit is refundable. Residents of other states and foreign countries are eligible.” (Quoted from their web site.)

How does an angel tax credit work? It’s simple. An angel makes an equity investment in a startup and receives a reduction in his or her state income taxes equal to some percentage of the investment. In Minnesota’s case, it’s a 25% credit. Minnesota is so committed to this, the tax credit is refundable. That is, an investor with no Minnesota tax due can get a refund equal to 25% of his or her investment, subject to the maximums. This means if I invest $100,000 into a qualifying Minnesota company, the state of Minnesota will send me a check for $25,000. The practical effect is I receive a $100,000 interest in the Minnesota company for a net $75,000 investment.

What do the taxpayers of Minnesota get out of this? They get a more robust startup economy, which will increase jobs, provide opportunity to its citizens, and ultimately increase taxes paid by those companies and their employees to the state of Minnesota.

An angel investment tax credit is an elegantly simple means of stimulating investment in our Idaho companies. The free market makes the investment decision. His or her tax savings increases the investor’s available capital. The company gets the investment. Our citizens get the jobs. Our state gets the tax revenue once the company begins to grow.

The Idaho legislature has flirted with this over the last few years.  I hope next year they will enact some type of credit that will favorably impact the availability of capital to our state's entrepreneurs.