It is not uncommon for a CEO/business owner to say, when asked about the exit strategy for his company, that he doesn’t really have one. At least, not one that is coherent and the result of thoughtful, thorough diligence. Some CEO’s say their exclusive goal is simply “to build a great company” and any thoughts beyond that are merely distractions to their work-in-process. Thoughts of “optimizing value for an exit” in a developing company don’t compute with many emerging growth company CEO’s. The prevailing paradigm is “I’ll worry about an exit when the time comes”. Bill Gates and Steve Jobs certainly would be in that group, at least early in their companies’ development.
I would argue that for business owners in general, and especially those trying to get across NO MAN'S LAND, there is an opportunity to take much greater control of their company’s destiny; by
focusing on future valuation and exit options. If the CEO follows a deliberate process, it may make an enormous difference in the future net worth of equity holders. Said another way, failure to take the notion of exit strategy seriously is likely to cost business owners millions of dollars. I have witnessed this dynamic first-hand, many times, in both small and mid-size companies. The reason to start early, and assess it often, is that it can’t be done in a short period of time; i.e. when you decide you want to sell your business. By then, it may be years too late.
Exit Defined
How is exit defined in this context? For midsize companies, it could be an IPO. In most situations for small to midsized companies, an exit is an event in which all or part of the owner’s equity is monetized, in the form of cash and/or stock in another company. The exit takes the form of a sale of the business, in whole or in part, such that a change of control occurs. Exits are most successful for the seller when the company’s “value” is optimized. That “valuation” is a function of many things.
Valuation
Valuation typically involves earnings (EBITDA) and/or cash flow, and a “multiple”. That multiple is a function of many factors (market, scalability, growth potential, capability, intellectual property, proven business model, etc.). Valuation of a business is the product of EBITDA times the multiple. Many business owners fail to understand that most components of the multiple are within their control. They need to identify, understand and incorporate these drivers into their long term planning—and then execute the plan. They need to run the business—month by month, quarter by quarter--according to metrics that measure their progress in building these drivers of exit value. They must “drive the multiple”.
Why is it important to understand this concept? Why is it necessary to plan the course of your company each year with this in mind, even though there may be no plans do an exit in the foreseeable future? How does a CEO “drive the multiple” effectively? Is it worth doing? The next article in this series will provide a specific example of the value of an early focus on exit value.
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Contact David at David.Gnass@newportboardgroup.com
image credit: EB5 blog
