Why You Should Resist the Allure of an Early Exit
The Canadian startup scene is ready to perform on the global stage -- but, according to two of Canada’s most active investors, it’s in need of a pep talk. Both Bruce Croxon and Anthony Lacavera argue that Canadian startups have incredible potential yet often exit early or sell out to large foreign companies. They feel like (and I would agree) overcoming this mentality and trying to cultivate companies from within will transform Canada into a 21st-century economic powerhouse.
Croxon's and Lacavera's perspectives resonate with me because I’m a huge proponent of entrepreneurs aiming big and building for the long run. Too often, founders race toward an exit strategy instead of building scalable, sustainable companies. And even when this isn't the explicit agenda, venture capitalists can make an early exit inevitable. VCs are an important source of funding, but they're also fundamentally self-interested: They often want to get their money back as quickly as possible with the highest rate of return and the most favorable terms. Under those conditions, an exit might be mandatory.
VC funding can help get companies over the initial hurdles, but to write real success stories, alternative funding is often essential. It's time for more entrepreneurs -- in Canada and beyond -- to make decisions that will benefit their companies in the long term instead of just tomorrow.
Choosing your lane
When entrepreneurs think about building for the long term, an initial public offering is often the only option that comes to mind. While an IPO is certainly a purposeful path to financing -- and longevity -- it isn’t the only way to access the public markets.
Venture-stage companies looking to get through the market door should consider all of their options, including: a reverse takeover, in which a public and private company exchange shares and then the management of the private company takes control of operations; a reverse takeover of a capital pool company, which makes the above financing strategy available to smaller companies; and a special purpose acquisition vehicle, which is yet another avenue for larger companies to go public under an umbrella corporation.
If an IPO is still sounding like the most straightforward operation for your business, there are some key considerations to set in place before you approach the markets. Many companies don’t do their due diligence and scuttle their chances at a successful offering.
For instance, going public and meeting the requirements of a public company both involve complex accounting. You could flounder without sufficient staff, policies, and processes in place. As such, you should begin testing your financial strength several quarters before the IPO. This will illuminate whether your company is prepared to go public and ready to operate within the highest standards of corporate governance.
Here are four other steps to take before you're truly ready for an IPO:
1. Invest in proper management.
Company leaders need to understand capital markets and be able to engage with investors. This requires experience and the right image -- leaders need to project competence and inspire confidence in order to draw in support.
Elon Musk is a great example of how a leader’s public image can impact the health of a company. When he publicly insulted a British cave diver who was involved in the Thai cave rescue mission back in July, the public backlash contributed to Tesla's shares dropping 3.5 percent. Then, in September, multiple executives at the company stepped down from their positions, just as Musk's behavior during an interview caused shockwaves across the internet.
Most recently, he's been wrapped up in a settlement with the SEC. Not only was Musk ordered to step down as chairman, but both Musk and Tesla also had to pay $20 million fines to settle allegations that Musk had deceived investors. All in all, the company's stock is down more than 12 percent this year, and the takeaway is clear: It's important to understand how your management team is perceived by an external audience.
2. Tell a compelling story.
Companies need to demonstrate they have a smart business plan, have good growth prospects, and are the right size to attract institutional investors. A 2017 study funded by the National Natural Science Foundation of China found a link between investor excitement and early stock prices, which is why a compelling story is so important.
Many companies try to cultivate this narrative even after going public, as industries and audiences fluctuate. Take the carbonated beverage industry, for example. Soda maker PepsiCo began buying healthier drink companies to demonstrate to health-conscious consumers that it has a finger on the pulse of their wants and needs and cares about their well-being. As a startup, you can set the tone for your industry. Craft a story the markets will find attractive -- with a clear business plan to match.
3. Publicize your plan for proceeds.
Investors want to know how the funds from an IPO will be used and whether any are going to wind up buying out early VCs. You could be a victim of your own success if your company is raising proceeds but you can’t articulate what you plan to do with that money. Companies that don’t show their work look unfocused and investor-averse, and not having a defined use of proceeds can also mean unnecessary dilution for existing shareholders.
The public markets tend to reward those that deliver on promises to hit material milestones -- for instance, if a pharmaceutical company transitions from Phase 2 to Phase 3 clinical trials. Bottom line: A clear use of proceeds is a must for any financing, whether private or public. When Planet Fitness Holdings articulated an ambitious plan to refinance $707 million and provide cash dividends to shareholders, it excited investors enough to double the stock price in a single year.
4. Get to know your peers.
Your peer group says a lot about your own chances for a successful IPO. Take Instagram and Snapchat, for example. Both offer similar services, but Instagram is prospering after being acquired by Facebook, while Snapchat is languishing after going public. Companies should dream big while being realistic about their competitive landscape.
If you aren’t aiming to be acquired, are you sure you have enough room in the market? It’s one thing to decide you want to pursue an IPO and another thing entirely to avoid getting overtaken by a behemoth. Is your company going toe to toe with the likes of Amazon? Are you in a field likely to appeal to a bigger fish in the future? Your plans could be dashed if a major player decides to enter your industry. Forecast your market dynamic early on to leave room for the most realistic strategy.
The allure of the early exit is strong, and for some companies, it may be the very best option. But it’s rarely the only option. Startups ready to become global brands don’t have to settle. They simply need to put their own plans first and build the future they see for themselves.