← 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.
- [00:19]
B
Hello and welcome everyone. I'm Mike Lyon, founder and managing director of 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. I'm joined today by Jeff koons, who's an MD at the firm. We've worked together for about 15 years on M and A. He's a phenomenal software banker and has worked with many founders on successful exits and capital raise. It's fitting that Jeff's our first guest. He was the first employee at BPA and showed up with his own chair on day one. Welcome, Jeff. Excited to have you on our first episode.
- [00:52]
C
Excited to be here, Mike. Thanks so much.
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B
The first episode is all about the entrepreneur's dilemma. One topic at VistaPoint we talk to founders about a lot is when they should time their exit or capital raise. Let's talk a little bit about why you should sell when you're winning. Jeff, first of all, what is the entrepreneur's dilemma?
- [01:08]
C
Simply put, why would I sell my company when it's doing so well?
- [01:11]
B
Absolutely. Why should you sell when you're winning?
- [01:14]
C
You know, we spend a lot of time at VistaPoint walking founders through various considerations around how to time an exit, when to go pursue that liquidity event. If we were to force rank, what matters in terms of that timing? I think there's three things that naturally come to mind with our set of clients. The first and foremost is the actual state of the current business. So how is the business business going? What are the KPIs? Ideally, we're selling into a strong growth trajectory. So that's number one, you do not want to be selling your business on the decline. Number two is what's the state of the end vertical market you're selling into. So for now, there are a couple verticals that are doing incredibly well, and then there are some verticals that are just under pressure. So that end vertical is really important as well. And then the third one is the actual personal interests of the founder. Our clients tend to have a dynamic where they don't have to do a deal. They tend to be paying themselves very well, they own their own business, things are going pretty well. It's not like we've raised $75 million. The Fund Life is coming up for one of our investors and so we have to sell. Our founders tend to have A lot of personal interests that can drive the decision around. Is now a good time to go seek a liquidity event?
- [02:24]
B
That's great insight. One thing I always think founders don't really think a lot about is how their interests change over time. So for example, they start a business, maybe they think they're going to go public in five or 10 years. But what they don't realize is that their interest can really change over time about what's important to them or maybe what's best to the business. Talk a little bit about how founders attitudes can change over time.
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C
Yeah, this is something we see quite a bit. And I think there's two parts to this question. One is the risk profile they're willing to undertake. So when founders start a business, their risk profile is at an 11 out of 10. Right. Oftentimes they're taking out second liens against the house, they're maxing out the credit cards, and they are trying to disrupt a market or change the way a specific end market is doing business with software or product that is inherently risky. Just starting a business in general is wildly risky. And so what you see early on is a lot of big swings, some successes, some failures, quick pivots, you have a relatively small team at that point, everybody's really energized, working towards the same goal. As these companies scale and they gain ARR, they gain EBITDA positivity, the business becomes a lot more of a going concern. It actually becomes incredibly valuable just from a personal financial situation. And so what we tend to see over time is actually that risk tolerance decreases. The dilemma here is what actually made you successful early on. Taking a lot of these big risks becomes actually a lot harder to justify. Once you have an asset worth 50, 100, $200 million. And so what that can do is ultimately lead to that founder playing a little bit more on the defense as opposed to on the offensive side of things and just being a little bit less risk seeking, which can honestly be suboptimal when they're looking to go to that next phase of growth. The other thing I think, and I think a lot of founders out here will certainly empathize with this, is there's just this whole issue around scaling a company around hr. Most of our clients, they do not start their business in order to go hire 150 people to go figure out compensation plans, mediate the fight between Harry and Sally, whatever it may be. And as these organizations get to 30 or 40, then really about 75 and 100 plus employees, there's just a lot more HR process burden and operational headaches that come with it. A lot of our founders are not as keen on that part of the business building as per se. Figuring out the product market fit, solving the engineering challenge, disrupting the end market.
- [04:49]
B
Yeah, I think that point can't be emphasized enough. I mean, a lot of founders start for the product, the product market fit, and then the idea of growing the business and the HR issues that come along with that tend to be a big driver of transactions. And we joke about it a lot with founders, but it's definitely true. At some point they need some help and just don't want to do that. They want to focus on the product or the engineering, whatever the case may be.
- [05:10]
C
Yeah. And I can't tell you how many times we've talked about that. Crossing the chasm between I know every single employee at my company's name to. It's kind of strange that I don't know everybody who works for me anymore.
- [05:19]
B
Absolutely. One of the bigger misconceptions I see when talking to founders is this idea that they want to grow the business as much as they can and kind of take it to that natural endpoint like where can they take the business to. To. And then once they hit a plateau, they want to sell. In my experience, that's a really bad idea. Talk to me about why it's a bad idea to wait till you hit a plateau to sell your business or raise capital.
- [05:41]
C
I think there's just two big drivers there. One is that growth companies command a much, much stronger multiple. If we're in software as a service land, the ARR multiple. If it's a more transactional business, an EBITDA multiple, businesses that are growing well command a much higher price from a multiple perspective. So that's one. Number two, and this is often overlooked, I feel, when thinking about these transaction dynamics, is the risk profile that is associated with the exit. There is significantly more interest in a growing business and people who want to buy part or all of that business than a company that has plateaued or is potentially on the decline. And when you have less interest in your asset, your closing risk goes way up because you're dependent on much fewer parties than you would if you're growing and you have 15, 20, 30 different people interested in the asset.
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B
And I think one of the things founders need to really think about is the math around their exit. So if you're growing really quickly, you're going to get a high multiple on that business if you wait till the growth has come down. The multiple can decrease dramatically. So there's situations where you can run the business for two or three more years and either get less in terms of valuation or the same while you've taken all that risk during the intervening time. So I think understanding that math is really important and Jeff's great at helping founders understand the risks and rewards. So now that we've firmly established you want to sell during the growth phase, I think we're in violent agreement on that.
- [07:03]
C
Absolutely. 100%. 100%.
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B
Now that we've firmly established that, let's talk a little bit about what are buyers looking for? And can you hide a growth plateau from a buyer? Can you kind of trick them and sell when you've topped out and they don't know it? What do buyers look for, what kind of diligence they do, and how are you going to trick a buyer?
- [07:19]
C
The short answer is it's going to be nigh impossible to do it. These are very sophisticated entities. If it's a private equity firm or if it's a big M and a buyer, a big public company, as you can imagine, there's just a huge moral hazard in any M and A transaction. Because the question that we started this podcast with was, why sell when you're growing? If things are going well, why wouldn't you want to keep going? Is it because you're worried about the future growth of the business? So you step immediately into a scenario where the buyer is very focused on figuring out, is the growth sustainable, is it plateauing? Are they worried about the growth slowing down? And that's why they're looking to exit now. And just to put a finer point on this, a typical buy side diligence process, they're going to do market work, accounting work, audit the model and the projections that you have, do customer calls and references to make sure people are going to renew their contracts or talk to big customers about what they like or what they don't like about the business. Ultimately, the whole goal is the buyers are going to find out everything about the business. And you can imagine if you're going to spend 100, $200 million writing an equity check to these founders, there's a whole lot of risk there. And so there is a huge incentive for them to really go down to the studs on business diligence in order to determine, hey, is there weakening in the pipeline? Do we have concerns about churn rate moving forward? Does this new product launch that is showing positive initial indications of growth, is that just a bunch of early adopters coming in and then that's going to plateau. Honestly, it's almost the largest part of the business diligence process and the risk they're looking to evaluate. And then after that, it tends to be confirmatory stuff. Right. Make sure your revenues, your revenue, you've paid your taxes, things like that.
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B
One question for you. I know we're going to do a whole episode on this in the future about SaaS metrics and how that drives valuations, but give founders a taste for what does drive the valuation at exit for a SaaS business and what do they need to pay attention to.
- [09:09]
C
So there's a constellation of ones, but again, if we're going to rank the most important one, one A is growth, one B is growth. That to a buyer or an investor indicates you have solved one of the hardest problems in business, which is generating demand for a product. One of the reasons why our founder led bootstrap companies tend to attract such premiums in the market is they have actually done a hard economic thing, which is create demand for something that hadn't existed before. And that demand speaks to a market that is either underserved or true economic value that people are willing to pay for and so cannot emphasize enough. That growth metric being critical.
- [09:49]
B
So obviously it's impossible to time it perfectly when you sell your business. Right. There's lots of unknowns out there, we've touched on this a lot. But just to hit it one more time, is it better off to sell too early or too late? Talk about the trade offs on that. Assuming you can't time it perfectly.
- [10:03]
C
Yeah, perfection is always the goal, but impossible. I would say it is unequivocal to us that selling on the earlier side is better than selling on the later side. And again, it really comes down to these multiples and the premium you get for a growth business. Let's say you are growing really attractively 40% year over year year. Yes, your business might be smaller today than if you waited to sell two years down the road. But that smaller business times that higher revenue multiple that is going to end up being a higher number than if you were to wait two years and be at 15% growth. Even though you were able to grow the actual metric that that multiple is applied to, it is much, much better to sell on the early side. And then again, coming back to this risk concept, it's just so underestimated. Let's say you're able to sell your business this year for 100 million, you're able to wait two years, the growth slows, the multiple goes down, but it's a bigger base and you're also able to sell the company for $100 million. There's no difference in the exit price. You took an additional two years of operating risk to get there. And oh, by the way, during that period of time, you could have taken that $100 million and put it towards other yielding, higher ROI type endeavors just to get the same amount of money two years down the road. So not only from a time value of money standpoint, but more importantly from a risk adjusted standpoint, that former scenario is so much better for the founder. And then again, the other thing I would just highlight here is just pure closing risk related to the deal. There's so many more people who are interested in your company when it's growing 30 to 40% than if you're growing 15%. I mean a lot of these growth equity firms, they have fund mandates that say if you're growing less than 20%, we will not invest, we will not underwrite you. And if you go from in a process 3 Lois to 8 Lois, I can promise you that 8 Loi type outcome is going to give you a lot, lot more leverage, decrease your closing risk and give you a better chance of negotiating a much higher price upfront.
- [11:57]
B
That's great. So we've talked a lot about the L word. Liquidity. How does liquidity help a founder first and foremost?
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C
Again focusing on our client base, these bootstrap founders, just personal diversification of wealth. Look, I'm a banker. I do not have the risk profile that our clients do. I am amazed that their ability to continuously double down on their businesses. But at some point having 98% of your net worth tied up in a very illiqu asset, especially if you're not paying yourself very well on the dividend side, that's a very suboptimal portfolio. Now the returns are great when they've gotten it to a point where it is worth a lot of money. So you could argue that risk seeking has paid off in spades. But to continue doubling down on that risk profile at some point, it just makes me a little queasy frankly. So the personal diversification around liquidity is really, really important.
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B
We talked earlier about it's not an all or nothing proposition on getting liquidity. Talk us through the different types of transactions where get liquidity and what are the relative trade offs of each of those?
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C
Absolutely. At a high level, we think about the world in three different types of transactions. For liquidity, a minority transaction that's going to be selling less than 50% of the company, the founder will maintain board control at this point. There are minority deal terms in there that give investors control over things like exits. But that minority deal does provide this liquidity diversification for the founders. And they retain the most upside under this scenario because they'll own 60, 70, 75% of the business. And when you go do that big deal down the, you get more of that second bite at the apple. And you also get the benefit of bringing in these partner resources that they're going to bring to the table. The second one is a majority deal. So this is when our founders sell 60, 70, 80, sometimes 90% of their business, there's a whole lot more liquidity, right? If you do the 30% minority deal and you do an 85% majority recap, they're two and a half x the amount of liquidity. And when you're talking big numbers, there is candidly a difference between taking 20 million off the table and taking 60 million off the table. Now everybody again is going to have their own risk profile, but there's a lot more liquidity in that scenario. It creates even less risk because let's say the company does not do well after the deal. Well, you're really happy you sold 70, 80% of the company when you did, right? If you do end up plateauing at the same time, if the company does take off, it's not like you're totally missing out on the upside of that business. And so oftentimes our clients really like that majority recap deal. They get a bunch of liquidity, they still retain upside. But you are going to now be a minority shareholder in the company you founded. And some of our founders don't do well in that situation, right? They're in a board meeting and it's kind of whatever the PE firm says goes. But that's the cost of the money, right? Essentially that is what you're giving up. And then the final one is a full sale. So just a full M and A event, a big public company, maybe a private equity backed strategic, they're going to come in, buy a hundred percent of your business, so you get full liquidity. And then the other advantage is that you as the founder, you're kind of done right. Like our founders, I would say, are so used to calling the show shots, being the boss, having really quick, agile decision making. The idea of four meetings to set up the meeting to then make the decision is not super appealing to them. And so you do a great job transitioning the business over a six month period, maybe 12 months, and then you're out and you're onto the next thing and you just got a big old check to do it. So again, it really comes back to these personal interests. But I think one of the things that we are very good at at Vista Point, and frankly we're conscious of, is you don't have to make up your mind upfront about these different deal scenarios. You can run a process in which you're looking at all of these at same time and then figuring out what you want to do.
- [15:31]
B
That's great. So just to recap that a little bit, full sale, max liquidity, no control, very limited future upside. Majority recap, good balance of liquidity and upside, but again, not much control. You've sold the business and then the minority deal, limited liquidity, lots of control and upside. Founders don't always sell just for liquidity or valuation. We've talked a lot about that. Talk about some other interests and upsides into a founder selling some or all of their business. What else are they thinking about?
- [15:59]
C
This really runs the gamut. And I think, again, it dovetails back into the personal interest, which I just think we're so lucky to be able to take that into account that it's not this, like, stoic, cold IRR calculation. So sometimes our founders, they work a hundred hours a week, and they've been doing it for 10, 15 years. They would like to not work that hard. They've built something really valuable. And so getting that time back to go pursue other passions or interests, that's a big one. Obviously, the stress and energy related to being the sole proprietor. Maybe you have a couple other co founders in there. There's a lot of pressure. Everybody reports to you. You are responsible for their paycheck, for the success of them and their family. That is a big burden to carry for a long time. Part and parcel with that, frankly, is being able to spend more time with your family. I think there's a lot of family members of founders and entrepreneurs out there that having he or she back into the family life and family context is probably greatly appreciated. And you throw some liquidity in there, that's a pretty good outcome. And then the other one, we see quite often a lot of our clients, they're technologists, they're engineers, they're problem sol, and they're eight years into addressing this specific problem, and they're just kind of over it. They just want to go do something else. They want to pursue a new passion. They're inherently good at seeing a problem, figuring out a way to solve that problem and then building a business around it just by virtue of even having this conversation. But ultimately going on to the next challenge, being reinvigorated by figuring out a new product, a new product market fit. Or maybe it's something totally different. Maybe it's hey, I want to go coach little league with my son or I want to go start a philanthropic organization and I want to give back to my community. A lot of different things come in there when you, you don't have the all encompassing pressure cooker that is being the founder and owner of one of these businesses.
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B
So give us an example of someone who's done this well, made these decisions you talked about and you think did it exceptionally well in terms of both the valuation piece and also these other interests.
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C
Yeah, so we worked with a business called Securelink and it was a software business and they essentially helped anybody who was remoting into highly sensitive equipment. And so this business, it had unbelievable gross and logo retention and frankly it's some of the best we've ever seen. The founder had been growing that business business for about eight, nine years. He had actually stepped away from day to day operations to go recharge and then he had gotten back into the business to catalyze the growth again. When we ran the process, he told us that his strong desire was to personally diversify himself so get good liquidity for himself, but then have somebody who knew how to take this thing to the next level. And honestly he just wasn't interested in being the one who was going to do it. And so we ended up doing a big majority recap, over 70% of the business sold where he got liquidity on that. We ended up doing that deal with Vista Equity, who's a large blue chip private equity firm who is very focused, if not exclusively focused on B2B software companies. So we did that deal. He sold 80%, he got a ton of liquidity, he personally diversified incredibly well. And then the Vista team, they changed out the CEO. So they elevated one of the other folks over at SecureLink to be CEO. He did a wonderful job scaling that business. They did some add on acquisitions to basically enhance the product profile and subsequently four or five years later sold that company up again for a very big sum of money. And then Jeff was able to get his proverbial second bite at the apple there. And so I think he did a great job in terms of knowing what he wanted personally de risking his situation related to owning the business and then still retaining some really great upside where he was able to take some time away from this business while he had a bunch of very, very smart, motivated people who woke up every single day thinking about how do I generate a return on this equity? Which oh by the way, was also his equity and then ended up working out well for him.
- [19:37]
B
Fantastic. Great story. And Jeff did all that well? For sure.
- [19:40]
C
He did. He was the worst. He was the best.
- [19:42]
B
Well, to conclude here, we'll just give you some of the high level points that we talked about. Certainly selling during the growth phase helps for a higher valuation. Don't wait till you hit a peak because you're going to end up with a lower multiple and possibly a overall lower valuation. If you're worried about giving away upside, consider selling in phases. I think those are the key points we want you to remember and take away. Jeff, thanks so much for joining us on the initial podcast.
- [20:04]
C
Absolutely. I had a blast. Thanks so much for having me. Mike.
- [20:07]
A
VistaPoint 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. Security is offered through VistaPoint Advisors member Finra Sipic. This has been provided for informational purpose 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.