Exit Strategy Through the Eyes of an Angel Investor
Angel investors take lots of risks, and obviously they get paid ... but when and how?
Most people receive their paychecks bi-weekly or monthly. Freelancers get paid when milestones are hit, or the project is delivered to the client. In both cases, there is predictable cash flow. However, this is not valid for Angel investors.
Angel investors take lots of risks, and obviously they get paid, but when and how?
Securing early-stage funding is on top of the list for many startup founders. Quite often, it is secured from angel investors as few venture capital funds are interested at an idea stage. Usually, there is a PowerPoint pitch deck on the table and the angel investor may or may not buy-in. The risk is high as the pitch deck may never become a product, and even if it does, there may not be enough potential customers ready to buy it. Thus, it comes as no surprise when angel investors ask about the planned exit strategy. The reason is simple – an angel investor can cash out and make a profit if there is an exit or a subsequent funding round.
How to develop an exit strategy.
As an angel investor, I first look at the horizon and the projected ROI (return on investment). In general, I hold an investment from 3 to 5 years and expect to cash out and make a profit at the end of this period. Hence, I am very unlikely to invest in a startup that forecasts an exit event in more than 5 years.
The exit route has a direct impact on the projected ROI as it is not equal to sell a business to a competitor, plan an IPO or sell part of the company to a venture capital fund.
Here's how I developed the exit strategy of my latest venture – Transformify HR Software & Freelance Platform
First of all, I asked myself who would be interested in buying the company and why. It is an HR Suite comprising of HR Software, ATS, Freelance Platform, Employer Branding and Diversity & Inclusion Solutions.
A potential buyer may be interested in acquiring (i) the user base, (ii) the technology and (iii) the brand, as the Diversity & Inclusion solutions are built around it. Also, there are different exit routes that could be followed.
This exit strategy is built around a potential sale to (i) a competitor or (ii) a business partner offering complementing products or services. As Transformify partners with WeWork globally, hypothetically we could sell the business to our partner.
Why WeWork or a payment services provider would be interested?
It's simple – the two businesses complement each other. Transformify has thousands of business clients looking to hire employees and freelancers. Once they hire them, these businesses need an office. As WeWork offers office space, Transformify can easily refer new clients to WeWork as we do at the moment. On the other hand, WeWork has thousands of businesses and the more they hire, the more office space they need. Hence, WeWork can refer clients to Transformify and both businesses will grow exponentially.
A similar exit route involves a fintech payments provider. All freelancers using Transformify Freelance Platform get paid via the platform making Trasformify's user base an ideal addition for any payments provider looking to expand globally and grow its user base. User loyalty is the added value as Transformify's users get a job via the freelance platform and subsequently get paid via it. A potential buyer will see not only user base growth but also an increase in transaction volume and value.
Selling to a competitor
This exit route is built around technology and user base. A competitor may be interested in buying Transformify as our technology fits into their portfolio. Instead of building functionalities internally, they cut the go-to market time by buying a competitor. The same is valid for the user base which is time-consuming and expensive to acquire. Buying a loyal global user base will boost the growth of a competitor at no time.
In this case, a stake of Transformify can be sold to a venture capital fund. A VC may be interested if there are obvious synergies with other portfolio companies or the expected return on investment is lucrative in their eyes. What if they can grow the company exponentially and list it in 2-3 years?
A well-executed IPO at a high valuation means one thing – a skyrocketing return on investment for the founders and early investors. It's not easy to achieve, though. Looking at Crunchbase stats, it takes 9 years on average for a SaaS company to exit. The cost of an IPO is also considerable and the combination of all of the above makes it the least preferred exit route in this case.
When developing an exit strategy, startup founders need to take into consideration the profile of the investors they will be pitching. What is their horizon? Will they be interested in subsequent funding rounds? What were the exit routes of some of their portfolio companies? What was the ROI they managed to achieve so far? Needless to say, few investors will jump from joy if the forecasted return on investment is well below the average ROI they have managed to achieve so far.