Elements of a Crowdfunding Pitch #2 – Exit Strategy
In this series of posts we take a look at some of the building blocks of a successful equity crowdfunding pitch, to try & provide some guidance to entrepreneurs who are hoping to build a successful campaign. Following on from our first post on Financial Forecasts, we now take a look at Exit Strategies.
First of all, what is an exit strategy?
An exit strategy is a plan for how your investors (and you as a founder) will cash in their investments in your company. That could be through an Initial Public Offering, or “IPO” – a listing on a stock exchange which allows investors to simply sell their shares on the open market or, more commonly, through a trade sale where a larger company buys your business and in doing so purchases everyone’s shares.
Why does InvestingZone require an exit strategy?
The vast majority of investors who use InvestingZone are looking to make capital gains rather than income. This means that although they’re interested in backing growing business which are, or which will become profitable, they’re doing so in the hope of achieving a profitable exit rather than because they want to receive small dividends year after year.
Any sensible investor will follow the rule “don’t get into something unless you can see how you’ll get out of it” – this means they want to see a clear exit strategy which demonstrates firstly that the company’s management team understands the need for an exit and is working towards it as a goal rather than trying to build themselves a “lifestyle” business which lasts forever, and secondly that they have a credible idea of who might buy the business, why and what has to be achieved to make it happen.
What makes a good exit strategy?
Exit strategies vary from business to business but good ones have sensible characteristics:
- Credibility – Everyone can name a few companies which scaled like mad and got snapped up before they even worked out how to make money, but the reality is that it doesn’t work like that for most businesses. You need a realistic plan for the scale your business needs to reach before a buyer might be interested and how you intend to grow to get there.
- Backed up by examples – You might be able to name a few companies who might be interested in buying your company if all goes well. That’s great, but even better if you can provide examples of other business those companies have bought in the recent past, why they bought them and what they paid as a multiple of sales or profit. That way investors can assess, and begin to get excited about, the returns they might make by backing you.
- Sensible timescale – Investors generally want to exit as quickly as possible. They understand that backing early stage companies is an illiquid investment which they can’t sell whenever they like, but no-one wants his/her money tied up for too long.
However, it’s not always as simple as saying you’ll exit incredibly quickly, even if you have a plan that makes that seem possible. If your company is eligible for SEIS/EIS tax relief then it’s likely that investors won’t want to breach the 3 year holding period required because they’d lose their tax relief.
Many companies end up aiming for the 3 to 5 year “sweet spot” – long enough to provide time for plenty of growth and not to lose anyone their tax relief, but not so long as to put people off tying their money up. Remember though – the timescale has to be backed up by a credible growth plan and by those financial forecasts we discussed in our last post.
Are there any common mistakes?
For the most part we find that entrepreneurs understand investors’ need for an exit and perhaps just need a bit of help expressing their plans in a way which presents things in the right way. However, we do receive some pitches which miss the mark and it’s usually because they’ve failed to understand the points above. For example:
- “Investors won’t want to exit.” - We see some pitches where the entrepreneur has allowed his/her passion for what they’re doing to cloud the investment case, even leading them to state that they can’t see why investors would ever want to exit given the profits the business will be making. You might get lucky and find some investors who share your passion, but more likely you’ll put people off because they don’t want a never-ending investment and profit shares don’t attract the same tax reliefs under EIS as capital gains.
- “…and then Google/Facebook/etc will buy us.” – big companies are often acquisitive – there’s no doubting that – and their acquisitions are often high profile. However, simply stating that an industry giant will buy your company can come across as lazy thinking. Much better to hold that out as a possibility if it’s real but also to offer additional examples of players in your space which few may have heard of but which nevertheless buy companies for good money. That’s much more credible to investors and shows that you know your stuff.
- A disconnect between the exit strategy and the financial forecasts – we often see companies set out a plan to exit well before they’ve achieved scale. In reality this probably won’t be possible, and if it is then it won’t maximise value for your investors. You need to take a step back and compare your exit strategy against your financial forecasts – will the acquisitive companies in your space really pay decent money for a company which looks like your will at the end of year 3? If not, then plan to continue scaling to year 4, 5, whatever it takes.
Hopefully, by following the guidance above you can produce an exit strategy which is a strong part of your crowdfunding pitch on InvestingZone.