← The Path to Exit
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- [00:02]
A
Welcome to the Path to Exit, a podcast to help software and Internet founders understand the process to raise capital or sell their business.
- [00:20]
B
Hello and welcome, everyone. I'm Mike Lyon, founder and managing director at VistaPoint Advisors, and this is the Path to Exit. This show is dedicated to helping founders of software and Internet businesses understand what it takes to raise capital or sell their business and how to do it well. My guest today is Jeff Koons, managing director and founding member of VistaPoint Advisors. You'll recognize Jeff from previous episodes. In today's episodes, we'll discuss common milestones that cause founders to start seeking meaningful liquidity or a sale of the business. We talked previously about selling your company during a growth phase and how to prepare for a sale. We wanted to talk today about why founders actually pursue liquidity. In working with hundreds of founders, several key themes have emerged and we're going to discuss those today. In general, we found four key themes to drive founder activity. Inflection points related to the scale of the business, the changing role of the founder, the founder's view of risk, and attaining some key benchmarks. Jeff, let's start with the first one here. Talk to us about why an inflection point can really cause a founder to evaluate whether they should sell the business or get meaningful liquidity.
- [01:22]
C
Yeah. Hey, Mike, thanks so much for having me. Glad to be back on the path to Exit. So really what we're talking about here is certain scale thresholds. And what this theme revolves around is at a certain point, the business, in order to get to the next level, is going to require some different inputs. That could be capital inputs. So you have to hire ahead of key growth initiatives. Maybe you have to outlay capital ahead of a new product build that'll provide a product that the market's looking for. It could simply be expertise in getting a partner who understands what are some of the pitfalls of going from 1520 in ARR to 50 to 100. But at some point, the scale of the business and what requires requires for that business to be successful at the next stage doesn't always match perfectly with what enabled the founder to get to where they're at today. And so at that point, what we'll see is a lot of founders asking themselves, am I the right person to lead the company into the next phase? Maybe I am the right person, but I don't have the five, $10 million that I need to invest in order for the company to get there. And so ultimately, what we see is that mismatch or potential mismatch between what the company needs at a larger scale compared to the core assets that got. It oftentimes drives a founder or entrepreneur to think, maybe now is a good time to look, to seek external expertise or capital in order to accommodate or accomplish that next phase of scaling.
- [02:43]
B
Great points, Jeff. And I think this one is the one that has the potential to get founders in the most trouble. And what I mean by that is we've talked in the past about how you want to sell during a growth phase and you don't want your growth to heal over. This can be the one that's the hardest to anticipate. And if you're not investing ahead of the curve, once you get to 10 million in ARR, the skills and processes and people you need to get to 50 million in ARR is really different. And if you're too late on this one, the growth can really heal over and that can hurt you at an exit. So I'd say this is the one to pay the most attention to. Understand where that inflection point is and make sure you're prepared for it. Even if you are going to seek liquidity right around this inflection point, you need to be prepared for that so the growth doesn't flatten out, which will obviously have a big impact on your exit and the multiple.
- [03:29]
C
A great example of this is let's say the company's been really, really successful selling directly, but their sales team is kind of at capac. Maybe one of the next good growth areas is going to be a channel strategy. Well, to get a really good channel person that might be 3, $400,000 that you have to pay them, and that's a year, two years before you're going to see any revenue associated with it. They're hard, complicated to get off the ground. And so that's a very, very common inflection point where, okay, I need to invest in head of this, both money and people in order to get there.
- [04:00]
B
Absolutely. The second point we mentioned, which is the changing role of the founder, unlike the first one where I mentioned it could be hard to recognize that's coming, this one is really easy for the founder to understand. So, Jeff, talk about how the founder role can change and why that's a big driver of founders seeking liquidity or a sale.
- [04:17]
C
We happen to see this all the time. So our clients tend to be bootstrapped, founder led. They haven't raised a lot of money. Oftentimes this will be their first or second time trying to build a business. And what you see is that in the beginning the come up's the best part. So you start with, I have this idea, I have a problem I want to solve, I want to work with a certain group of people. I have a high affinity for whatever it is. The reason you started the business, then you start it, you make your product, you make your SaaS business and you start growing it. And there's a lot of fun that happens in there. It's chaotic, it's Messy, everybody's wearing 30 hats and there's just this energy that's unlike anything else. When you're getting a company off the ground, then all of a sudden you're at 40, 50, typically more like 75 employees, the operational burden really starts changing. Whereas you used to think about what's the product set that's going to have the best product market fit for my icp, all of a sudden it's, well, we have to change the commission plan because the BDRs are upset because they're doing all the work and the AES aren't closing it. And so now I need to manage that. Or hey, we're starting to have these weird fiefdoms between product and marketing. And product doesn't want marketing's input, marketing doesn't want products input. Whatever it is, mediating and adjudicating those kinds of business issues is just very different from how do we create the best product, how do I go sell this thing? And a lot of our founders really like that first part of it. Building the product, solving the problem, getting those initial sales. And then in our experience, founders rarely enjoy the HR processes. Some of the more mundane business building what we might cheekily refer to as the Harvard MBA job, where it's about professionalization, putting systems and processes in place to scale, all of that is really important. But most founders did not start a business to design a better commission plan for their sales team. And so you tend to see this mismatch between man, I have this business I love, I'm really proud of it. But my day to day, I just don't love what I'm doing anymore. And oftentimes because you're the founder, you have to do that stuff. It just creates a very different day to day life for that founder. And sometimes they're just saying, look, I'm not really keen on doing this for the next four to five years. It's not what I enjoy, it's not what gets me excited, I know I need to do it, but maybe it's time to look at options to see if I could not be the one who does it.
- [06:31]
B
And I would say, honestly, other than the potential for capital gains rates going up, founders spending more time on HR is a big reason why they pursue transactions with us. It's just the HR thing can be really draining on a founder. And the thing I've noticed over time is the more product and tech focused the founder is, the more they tend to struggle with spending a lot of time on hr. If the founder's a little bit more on the sales and marketing side of the business and that's where their interest is, I've still seen them struggle with that, but it's more manageable. So I think if you view yourself as a product customer, tech focused founder, you're more likely to not enjoy that part of the job. And unfortunately that becomes a big part of the job when you reach scale. It's all about the systems and processes and it's not as much about the product and the tech. Now there can be a way to manage for that through a transaction, but as you're thinking about your interest, just know that there's a strong correlation there.
- [07:23]
C
We were picking on HR because that is by far the one that gets highlighted the most in our conversation. But think about things like risk and compliance. So when you're a small business, you're not overly worried about making sure your sales tax is all up to date. You want to do a good job, not the end of the world. You're not worried about ISO certification and compliance unless it's certain industries. And now all of a sudden these things become very important, critical parts of the business. And as you said, Mike, it's not on building product, it's not on delighting the customers, it's making sure things are systematized and scalable.
- [07:54]
B
Absolutely. Moving on, let's maybe talk about the third category here, which is the founder's view of risk and how that changes. Obviously when you start a business, it's risk on. And you know, a lot of founders aren't even sure if they're going to be successful, but that changes dramat over time as the company has real value. Jeff, maybe talk a little bit about how this changes and how this kind of manifests itself in a transaction.
- [08:16]
C
This one's really common. And it's funny, I think there's different levels of self awareness for founders in terms of is their risk profile changing. But simply put, to start a business is just kind of inherently crazy, right? The success rate is really, really low. The kinds of folks who we love who ultimately start these businesses have a risk tolerance where they're quitting a great, well paying job, they're taking out a lien on the mortgage, they're maxing out credit cards. This is true risk. On to 11 profile kind of business building. And ultimately that's what you need in order to one take the jump into entrepreneurship to certainly if you're going to bootstrap it, right, it's not like somebody's writing you a check for 10 mil and if you lose and not the end of the world, I'll go do something else. This is everything, this is your livelihood. So that is a crazy high risk profile. And that is what it takes, we think to really disrupt a market or to actually make and build a big business, you need to disrupt things. And that's just an inherently risk seeking proposition. Then what we see is as the business grows in value, maybe the company's worth, you know, 50 million, a hundred, 200, 300 million in enterprise value, all of a sudden you're risking a lot. At that point when you just started, yes, there's personal risk related to how you finance the business, but now all of a sudden you have what is essentially life changing levels of wealth, that you are taking a risk every single day, that you have not properly taken money out of the business. And so what happens is the founders all of a sudden go from risk seeking to a little bit more risk averse. Well, if we do this and it doesn't work, our ARR might slow down. Whereas in year two, you wouldn't even care about that, right? You would say, look, we're going to have a bunch of different ideas and a bunch of strategies and the ones that work great, we'll do it even if we take a step back. But once you're protecting something, we see that risk aversion start to come in. And so ultimately we feel that's actually at the detriment of the business. So what we'll see is a lot of founders go into this more risk averse mode. They'll make more risk averse decision, they won't take big swings. And there are often times at this point of the business where you still need to make those big swings. But our client, our founder, our entrepreneur, they're just really not comfortable doing it because they have so much at stake at this point. Whereas first 2, 3 years of the business, you just don't have nearly the amount of wealth or potential monetary value at stake. And frankly, you don't have the same level of personnel counting on you when you have 7,500 employees all of our founders feel the weight of making sure they're being a good boss, they're being a good owner, they are providing good opportunities for their employees. And it can calcify into this risk aversion that ultimately tapers long term growth.
- [10:55]
B
I think this is one that starts to build and then it becomes a big risk. And obviously when a founder seeks outside advice, no one's going to tell you you should have all your wealth tied up in an asset that has that much value. So this one's a really common one. I think they're a little bit easier to see coming, but definitely a focus area. The last point we wanted to touch on here is achieving some key benchmarks. This one I think really forces its way on founders because there's a certain size transaction that buyers want to do, both strategic size and private equity firms. And there's these thresholds you get to where it really starts to make sense. And not surprisingly, these buyers are really good at figuring out when you're at that scale. Even if you're not advertising your revenue, they can see your employee account on LinkedIn and if you're bootstrapped, they have a good sense for what your minimum revenue number is given your number of employees. So, Jeff, maybe talk about these key benchmarks and how the inbound interest starts to really ramp this up quite a bit.
- [11:47]
C
I think you said that really nicely, Mike, that this is kind of imposed on the founders. I don't think I've ever talked to a founder who hasn't told me, well, I'm not a 10 million in ARR yet, so obviously I can't do a deal. You absolutely can do a deal below that. But there is a lot of truth to the number of buyers, the number of investors, the overall interest level. You'll get at 10 million in ARR as opposed to 5,6 million in ARR. It is true there is a lot more interest the company is going to assuming the growth rates there be worth more than it would. And so I think that's one of the targets that a lot of founders and entrepreneurs have in their mind. I want to get to 10 million ARR, maybe 15 million in ARR and then at that point I'll look for a deal or I want to get to cash flow, break even or slight profitability, then it'll be time to go. If we're talking more operating metrics, maybe it's a retention threshold though. I want to get my net revenue retention over 110% or my gross revenue retention over 85%. And at that point I'll be interested in looking at a transaction. But I could not agree more that that is more founders being via osmosis, talking to all the private equity firms that call them talking to fellow entrepreneurs or other folks who have sold businesses. These benchmarks exist for a reason and there is truth behind them. I don't want to bury the lead here, but then you have the entrepreneur really managing to these external benchmarks and so they'll say, hey, this is the line. Once I cross it, now I'm ready to go. And again, there's nothing wrong with doing that. There's a lot of truth to if you can get to 10 million ARR, you should probably wait given what the pool of buyers and investors becomes in the associated valuation. But this idea that there are these core benchmarks that once I hit I'm going to be in really good shape to sell my business, there is a lot of truth to that. And so we will talk to founders and entrepreneurs that they look 10 million ARR, break even retention looks like this. Once I'm there, I'm ready to go because based on all the external information I've gotten, I'm going to get a multiple between X and Y, which is then interesting or exciting to me.
- [13:45]
B
And one of the things we just want to chat about a little bit because we get a lot of questions about this, is how should founders be thinking about the macro environment when it comes to trying to time a transaction? So we talked about a lot of personal drivers around transaction, which frankly in our experience tends to be the real driver of when founders pursue liquidity. But Jeff, maybe talk about how a founder should think about the macro environment when they're going to sell business or raise a lot of capital.
- [14:07]
C
This is one of those questions that I think is best almost answered in the inverse. And I would put it this way, it could be the greatest market of all time. If your company is not performing well, you're not going to get a good deal. Right. And so it's not just the market. This being said, it should have some input into how you think about timing. And so we had a lot of conversations in 2022, 2023 where we talk with founders and they would say, look, the market's not that great. I don't want to sell and the market wasn't that great. It was good for a lot of our assets. That that's a little bit of a different conversation. But I understand somebody saying, all things being equal, I would rather not go out. This being said, if A company was, let's say growing 50% over 10 and ARR. Profitable. Good retention metrics you still could have. And we had gotten 15, 18, 20 times ARR. So those good deals are still out there even in suppressed markets for really, really good companies. And so I would say always company and personal considerations first and then if there's a marginal decision to be made, I think it is fair to overlay the macro environment. And the nice other part about thinking about just your company first is that so many of our companies are somewhat impacted by the broader market, some more than others. So like real estate technology right now, it's a tougher place to be given the interest rate environment. As interest rates go down, then real estate is hopefully going to start unlocking and then those businesses are going to be poised for success. So for that business, their business profile in the real estate market is just more important than the general market conditions. But as you could imagine, if you have really good company performance, if your specific vertical is doing well and the general deal environment is positive, that's of course going to be the best time to sell your business. But I do think it would be a mistake to time the broader market conditions to something that on the company level is suboptimal because it's not going to make up.
- [16:05]
B
I think that's really good advice. The last thing I just wanted to mention is if you're thinking about these interests and when you pursue a transaction, definitely seek some outside advice around timing. Sometimes we'll talk to founders who have spent a ton of effort in getting ready to market their business and they have all these interests driving them to pursue a transaction. But there's some things that just make it impossible and sometimes those are a real surprise with founders. So I would say just get some outside counsel from folks who do this a lot to understand if you're in the strike zone. So you don't waste a lot of time that you could have spent focused on your business or frankly maybe even addressing the issue in the business to get to an exit. But every once in a while we see that and just feels like a lot of wasted time.
- [16:46]
C
To me, what comes to mind would be like customer concentration. So the business is growing really well. You have one big customer who's like 35% of our revenue founders, really excited about everything. Then that level of revenue concentration is a concern. If you wait eight months, get some of these contracts signed and that 35% goes down to 15%, you're going to have a much better outcome just because of the facts on the ground. And Mike, as you said, any good third party is going to help you walk through that and understand what some of those potential pitfalls could be.
- [17:16]
B
Absolutely. In today's podcast we talked a lot about what are the actual interests that typically drive founder towards a deal, talked about inflection points, the changing role of the founder, changing view of how a founder views risk, and some of these key benchmarks that tend to drive a transaction. We touched a little bit on how to think about the macro environment in your timing and then just to double underline what we said before, definitely seek some outside advice if you're thinking about it and make sure now is the right time for you based on all your interests and also the types of opportunity you're going to bring to market. Jeff, thanks for joining us again.
- [17:48]
C
Pleasure as always, Mike. Thank you so much. Really enjoyed the conversation.
- [17:51]
A
Disappoint Advisors is a founder focused investment bank that advises software and Internet founders through M and A and Capital raised transactions. We are a fully unconflicted investment bank who only works for founders on the sell side, so you know that we're always representing your best interests. Securities offered through VistaPoint Advisors member FINRA Sipic. This has been provided for informational purposes only. It is not intended to address all circumstances that might arise. Testimonials from past clients may not be representative of the experience of other clients and there is no guarantee of future performance or success. Clients are not compensated for their comments. If you have any questions about the process of selling your business or raising capital, reach out to a member of our team or check out the four Founders section of our site by visiting four Founders Guide.