Click to Print

Enticing Investors

Early-stage investors need to know how they'll get a return on their investment in your company, and IPOs aren't the answer.
January 15, 2001

Several recent questions from readers have focused on "what's a good exit strategy" to propose to the investors of your new venture. It's amazing how many entrepreneurs are content to simply propose that the firm hopes to eventually go public, at which time the original investors can realize marketable value for their stakes in the firm. But that response is perhaps the most generic and overplayed strategy when it comes to formulating a plan for financing your new business. The ratio comparing the dozens of IPOs in the United States every year to the thousands of new ventures launched is a minuscule percentage. Yet more than 70 percent of all formal business plans presented to angel investors and venture capitalists name "going public" as the primary exit strategy for the proposed company. And many of these expect that event to happen within just four years from the launch date.

Let's start with the definition of--and rationale for--the exit strategy. First, this provision in the business plan outlines a method by which the early stage investors can realize a tangible return on the capital they initially invested in the venture. The entrepreneur spells out a "reasonable" scenario by which a later round of funds is expected to be raised, through which the stockholders can sell their shares and realize a capital gain. Second, the intent is to suggest a proposed window in time that investors can tentatively target as the "investment horizon" of their involvement in the early-stage funding deal. The founding team wants to assure investors that the venture will grow to a point whereby the initial investors can cash out their stakes at a high return on investment, given the significant risks they assumed when they decided to fund the start-up.

The problem in projecting an exit strategy is you're basing it on several major assumptions. The speed of market penetration, the ability to sell at expected price levels, the costs of doing business, the margins on sales, the management team's ability to arrange consistent deals, and the impact of competition and other economic factors collectively affect the new venture's projected market share and bottom line. Certainly, when these are all aligned in the most optimistic configuration, the firm will experience significant market share, consistent high-growth sales rates, strong profit margins and positive earnings. And such a scenario in the first two- to three-years is typically the story told by firms that eventually go public.

But the overwhelming majority of new ventures are unable to realize their most optimistic projections. So if an IPO is no longer a realistic possibility, what other exit strategies are available for early-stage investors? There are four basic categories of exit strategies besides the IPO, and these comprise the more typical ways that investors get to cash out as the venture makes forward progress. In order of occurrence, these are:

Remember, investors are very aware that you cannot guarantee an exit strategy. But you can offer them more than the wishful thinking that you'll make an IPO in three years.

David Newton is professor of entrepreneurial finance at Westmont College in Santa Barbara, California. He is the contributing editor on growth capital for Industry Week Growing Companies and a moderator on small-cap stocks for His books include Entrepreneurial Ethics(Kendall-Hunt) and How To Be a Small-Cap Investor(McGraw-Hill), named November 1999 book-of-the-month by Money magazine and a 1999 Top 10 book by Forbes. His latest book is How To Be an Internet-Stock Investor (McGraw-Hill). He has written or contributed to more than 80 articles for publications including Entrepreneur, Your Money, Business Week and Solutions, and has been a consultant to emerging, fast-growth entrepreneurial ventures since 1984.

The opinions expressed in this column are those of the author, not of All answers are intended to be general in nature, without regard to specific geographical areas or circumstances, and should only be relied upon after consulting an appropriate expert, such as an attorney or accountant.