Investment+exits

Spin-off Companies
**Module 10.** **Investment exits**

A very common way of financing new businesses is by venture capital. In return venture capital expects significant return on investment when the time to exits the start up company comes. It depends of the development stage of the company in which it has been invested and usually happens after few years. In other words exit strategy is cashing out the investment. The most common exit strategies are: //Initial Public Offering (IPO)// – When a firm goes public and its stock offering is listed on the stock market. //Merges and acquisitions (M&A)// – Small technology start ups are attractive acquisition target to well established market leaders with strong R&D centers, if the innovations developed in-house are in same line with the buyer's own research and may add value to the profitability of the company. //Redemption// – The company (start up) in which has been invested may ask to buy the venture capital stocks at cost plus certain premium.

The book of Dr. Tom McKaskill __Invest to exit__ offers a very nice and extensive reading about the exit strategies most frequently practiced by the angels and the venture capital. In parallel with the exit strategies the reasons for fail or success of the start ups are elaborated as well. The findings presented in this book refer mostly to the investment/entrepreneurial landscape in Australia, USA and UK. It can be found online on the following link: http://www.brisbaneangels.com.au/images/Resources/McKaskill_Invest_to_Exit.pdf

Considering that the book is nice but comprehensive reading, some highlights are extracted in the text bellow:


 * The reason for failure and success**

The goal of every investment is to earn significant return on the money invested. However it is not that straightforward. The new business first has to survive and after that to grow. In their early stage young start ups usually face the several uncertainties (from the book): The product is often unproven The management team is inexperienced. There are gaps in the management team <span style="display: block; font-family: Arial,Helvetica,sans-serif; text-align: left;">The market is developing and yet to be established <span style="font-family: Arial,Helvetica,sans-serif;"> Competition is still uncertain with new products emerging

<span style="font-family: Arial,Helvetica,sans-serif;">Those uncertainties may lead to failure. The most common reasons for failure are (from the book):

<span style="font-family: Arial,Helvetica,sans-serif;"> Customer failure (unwillingness of customers to pay for product or service, or insufficient demand) <span style="display: block; font-family: Arial,Helvetica,sans-serif; text-align: left;">Technological failures (inability to deliver the promised functionality). <span style="display: block; font-family: Arial,Helvetica,sans-serif; text-align: left;">Operational failures (inability to deliver at the required cost or quality levels). <span style="display: block; font-family: Arial,Helvetica,sans-serif; text-align: left;">Regulatory failures (institutional barriers to doing what’s desired), and <span style="display: block; font-family: Arial,Helvetica,sans-serif; text-align: left;">Competitive failures (a competitor’s entry changes the rules of the game). <span style="display: block; font-family: Arial,Helvetica,sans-serif; text-align: left;">Sustainable growth is purpose of every company. However in this development process a company is exposed to some challenges. Small business does not look same and does not share the same vision and drive as large business. New business is usually born by the motivation and vision of their founders. As the business grow and new people come in, for the most of them it is just a regular job; they do not share the original mission and vision. Hence, the management style and organizational culture are subjected to change. Complexity increases dramatically with the volume of staff, revenue, product, location, customers. Each added level of complexity asked to be managed differently. That is what the entrepreneurs very often overlooked in their endeavors to establish market position. For venture capital is very important to recognize when to take the exit. If the exit take place within first few years the return on investment is higher than if it happen after longer period of time.

<span style="display: block; font-family: Arial,Helvetica,sans-serif; text-align: left;">So far, the reasons for failure have been examined. That is the one side of the coin. The other side is the probability for success and what are the key drivers behind this success. <span style="display: block; font-family: Arial,Helvetica,sans-serif; text-align: left;">Company has sufficient capital <span style="display: block; font-family: Arial,Helvetica,sans-serif; text-align: left;">Management is capable and focused <span style="display: block; font-family: Arial,Helvetica,sans-serif; text-align: left;">Production and component sourcing goes as planned <span style="display: block; font-family: Arial,Helvetica,sans-serif; text-align: left;">Competitors behave as expected <span style="display: block; font-family: Arial,Helvetica,sans-serif; text-align: left;">Customers want product <span style="display: block; font-family: Arial,Helvetica,sans-serif; text-align: left;">Pricing is forecast correctly <span style="display: block; font-family: Arial,Helvetica,sans-serif; text-align: left;">Product development goes as planned <span style="display: block; font-family: Arial,Helvetica,sans-serif; text-align: left;">Patents are issued and are enforceable. <span style="display: block; font-family: Arial,Helvetica,sans-serif; text-align: left;">The key drivers are: <span style="display: block; font-family: Arial,Helvetica,sans-serif; text-align: left;">**//The Market://** <span style="font-family: Arial,Helvetica,sans-serif;"> Right place, right time; The compelling need to buy; The right customer; Channels to market <span style="font-family: Arial,Helvetica,sans-serif;">**//Realizing the Opportunity://** <span style="font-family: Arial,Helvetica,sans-serif;"> Innovation as the driver; A competitive advantage; Sustainability; Scalability <span style="font-family: Arial,Helvetica,sans-serif;">**//Making it Work://** <span style="font-family: Arial,Helvetica,sans-serif;"> A clear vision; A long term strategy; Robust margins; Management of risk <span style="font-family: Arial,Helvetica,sans-serif;">**//Turning the Wheel://** <span style="font-family: Arial,Helvetica,sans-serif;"> A capable management team; Profitable
 * The main factors one business to succeed are (from the book):**

<span style="font-family: Arial,Helvetica,sans-serif;">External link on this subject:

http://www.businessinsider.com/why-some-startups-succeed-and-others-fail-10-fascinating-harvard-findings-2012-1?op=1


 * <span style="font-family: Arial,Helvetica,sans-serif;">Going public **

In periods of economic boom and rapid growth of some industry (computer industry in the years 60th is taken as an example), IPO is perceived as a yardstick to measure the worth of the venture and success of the venture fund. Following this logic the firms eligible for investment has been selected by their likelihood of delivering IPO exit rather than trade sale. In order to reach the stage of public offering a company has to satisfy some requirements. They are listed below (from the book):


 * Revenue - $20 million + ($100+ the most successful)
 * Net Profit - Profitable for three years with minimum of $2 million in the year prior to listing. Projected profits growing over next few years
 * Scope - National or international markets
 * Portfolio - Range of products with some in different markets
 * Potential - Major national leadership or global markets
 * Management - Majority with public corporation experience and some with experience in larger corporations
 * Board - Significant industry and public corporation experience
 * CEO - Able to deal with market analysts, institutions and shareholders
 * R&D - Products in various stages of development to ensure continued market leadership
 * Cash - Sufficient funds to meet forecast plans without further capital raising
 * Funds Use - Funds raised to be used for market development, innovation, overseas expansion, acquisitions, working capital, repayment of debt
 * Advantage - Clear competitive advantage based on strong intellectual property and/or proven innovative business model
 * Public Awareness - Products and their benefits are easily understood by the public
 * Support - Listed shares are large enough in value and number in institutional and public ownership to encourage market analysts to track the stock. Generally this means a market capitalization of at least $100 million

Not every company is able to satisfy those requirements. Only small number of start ups can achieve IPO. The other, indirect way to reach the public listing is via merger with some publicly listed company, which is usually seen as cheaper and quicker method. There are two types of exit via sales: financial exit and strategic exit. Financial exit is based on revenue, performances of the company and how health the business is. Strategic exit is based on the importance, synergy that some small business has for some larger corporation and it is usually related to biotechnology or nanotechnology start ups.

As has been stressed in the beginning the number of IPO depends of the market conditions and economic trends. The periods with high numbers of IPO are known as "hot markets". The have some common characteristics (from the book):

The initial fuel is provided by a breakthrough innovation (e.g computer power, disc capacity and memory chips in the 70s and 80s, the internet in the early 90s and the genome project of the late 90s).
 * The breakthrough innovation has to be widely available with relatively low cost of entry for new ventures.
 * The innovation has to support numerous applications, many of which have global potential.
 * New ventures need to be open to external investment, especially through IPO activity.
 * The applications have to be understood by the general investing public.
 * Early entrants into the market have very high revenue growth rates.

This favorable conditions are over when one of the following events happen (from the book):
 * A market leader fails to meet a revenue forecast.
 * A market leader is found to have misrepresented revenue recognition or has some other significant reporting irregularity.
 * A potential market leading product fails to satisfy a major milestone such as FDA approval or a product release date.
 * The whole market enters a downturn because of a major economic crisis.


 * Merges and acquisitions - Finding a strategic buyer**

For lot of businesses, particularly research intensive businesses oriented to development and commercialization of new scientific solutions, the most convenient way to exit is selling the business to some large corporation with strong R&D center. In the endeavor of finding strategic buyer a company has to look whether its business is complimentary to the potential buyer's business, either by adding value or resolving some problem.Most often venture capital or angels are those who are seeking for strategic buyer, rather than entrepreneurs. The characteristics that they look for and examine searching for acquirer are (from the book):
 * Who makes money when I make money? - studying partners
 * Who does not make money when I make money? - studying competitors
 * Who can make more money than I can from my products?
 * Who can remove a constraint on my business?
 * Who has a problem I can fix?
 * What threat can I reduce or eliminate?
 * Who sells to the same customers I sell to?
 * Who uses the same technology I use?
 * Who needs my customer base?
 * Who needs my technology or people?

The final goal of every start up for sale is to find competent buyer. According to some recent research done by Bain & Company companies successful in M&A activities have some common features like (from the book): They were frequent acquirers. That is, they had an M&A program that undertook regular acquisitions; They typically started with small deals and gradually became more expert at acquisitions and then progressed to larger deals; The size of the deals was generally small – often less than 15% of the parent company’s capitalized worth; A clear return on investment case was made for the acquisition and they were prepared to walk away if their criteria was not met; A comprehensive due diligence was undertaken of the potential target with a strong emphasis on the integration effort. This included a serious consideration of the culture match between the two businesses; Frequent acquirers set up benchmarks so they know that the integration effort is on track and have processes to deal with under-achievement; Successful acquirers have an acquisition strategy which targets potential firms that offer value to their core business and builds relationships with them prior to formal discussions;

The buyer will be also interested in evaluating some aspects of the business intending to buy. The three main aspect evaluated before making decision for purchase are (from the book): What are the inherent risks in the business being acquired? What issues will they have to deal with in the change of ownership? What costs, delays, problems and stresses will they experience in achieving the acquisition objectives.


 * Conclusion**

As a final note the author of this book implies that the ultimate goal of every venture capitalist or angel is to ensure the return on the investment rather than to support the development of new technologies or help young start ups. Thus on the entrepreneur/scientist is to convince the investor that his/her findings are economically feasible and profitable in long term. [Here is the meeting point between the science and the business. The interest of the science is to develop the knowledge and implement the same into practice. The interest of the business is to capitalize on that. Both, harnessed together drive the world forward... ]* IPO is considered as a limited option, rather as an exception than as a rule when it comes to general attributes about the start ups. Most convenient way to cash out the investment is selling the business to some large corporation, interested in the further utilization of a company's capacities and resources. On the buyer is to develop the new technology into full potential, on the venture capital and entrepreneur is to find a suitable buyer.


 * The thoughts of the author of this text.