As a founder, you can get a pile of money in one of four ways:
- You generate profits and keep some (dividends)
- The company becomes valuable and someone buys the whole thing (acquisition)
- It gets very big and very valuable and you go public (IPO)
- An investor buys some of your shares directly from you, generally as a small part of a larger funding round (taking money off the table)
Within the second category, there are 3 types of acquisitions which each behave quite differently:
- The company has failed, but manages to sell off something of value (patents, team, etc) on the way out (asset sale or talent acquisition)
- You’re making solid revenue (e.g. $5mm/year) and someone buys you to add that revenue to their portfolio (revenue-based acquisition)
- You’re “strategically” important in a battle between titans and one of them pays an exhorbitant sum ($100mm+) that is hugely disproportional to your apparent value (strategic acquisition)
Revenue-based exits (the middle option) are interesting because they are largely under your control. If you can get to 5 million a year in revenue (which is hard but doable), then you can sell the company. Specialists exist who can reliably sell businesses like these for a multiple of their revenue or profits (your accountant will know one). The value multiple varies by industry and is increased by positive factors (e.g. companies that can run without founder-involvement or which have a premium brand) and decreased by others (e.g. all your revenue comes from one big customer). These exits are what drive the SME world, but we don’t hear about them because there’s no juicy story for the press.
On the other hand, we hear about strategic exits all the time because they seem to make no sense and are a fun story. For example, Whatsapp being worth ~$20B? But that price tag is a bit of a red herring since it assumes that there’s an intrinsic quality of Whatsapp which makes it worth that. But in a strategic exit, you want to think of the startup’s value as a percentage of the acquirer. Whatsapp isn’t worth $20B; it’s worth 20% of Facebook. If Facebook was only worth $50B instead of $100B, then Whatsapp would have been worth half as much as well.
Imagine that Facebook and others (e.g. Google+) are jousting for position. Facebook has the advantage of having the best social graph and the highest engagement, which is very hard for someone else to break. But Whatsapp has both the graph and the engagement, which means that if Google acquired it, it could be used as a weapon to attack Facebook. Alternately, Facebook can buy it first to extend its lead. So there’s a bidding war between these big players to see who values the playing piece more. Same deal with Amazon buying Twitch; it had nothing to do with Twitch and everything to do with Amazon wanting to win against Netflix.
Most big ($100mm+) acquisitions follow this pattern. The numbers look absurd compared to a startup, but they’re relatively small when you look at the playing board on which the startup is sitting. That’s where the “strategic” bit comes from.
Unfortunately, the nature of strategic exits means they’re completely outside of your control. If you want to go big like Whatsapp and friends, then you have to get very lucky to be the key piece in an important game that much bigger players are engaged in. You can increase your odds by having insight into the market and its future, but you can’t plan an exit like this. Even if you succeed at everything, you’re still likely to be denied your prize.
While it isn’t exactly breaking news, the reliable path is still to focus on revenue and profits. Not a lot of people think about revenue-based exits, so I guess I hope spreading the word can help finish off the myth that bootstrapping equals small and unambitious. As John Mullins showed in The Customer Funded Business, you don’t need to choose between being bootstrapped or being big; you can bootstrap your way to scale as long as you’re choosy about your business model. And with the availability of revenue-based exits, you don’t even need to delete your bookmark for private islands for sale.Read More »