Where exits go wrong

image The way that a lot of VC backed companies go about selling themselves has been bugging me for three or four years now and the reasons why came into sharp relief for me as we reviewed the sixty odd companies in our portfolio over the Thursday and Friday of last week.

Before I get to the main point of this post and highlight some common mistakes that get made I want to set the scene by saying here at DFJ Esprit we think of ourselves as being pretty good at realising value for our companies via M&A.  Data is difficult to come by but by our estimates we account for around 10% of VC backed exits over $35m since 2004 – which we believe is more than any other active European VC – and a few of those deals enjoyed some pretty special prices as well.  We are also pretty busy on this front right now with three of our portfolio in exit discussions that could close imminently (and my best guess is that two of them will).

However, post the acquisition of the 3i portfolio last summer we need to up our game further, and we have been doing a lot of thinking about what we can do better.  These are my four main takeaways.

  1. Don’t launch a process too early – it is an old VC cliche that companies are bought not sold, and you are almost certainly not going to maximise value by launching a process before you know that there is definite interest, ideally from two or more suitors.
  2. Make sure the pitch is grounded in reality – getting the best price is all about selling a big story, but if there is a disconnect between with what is actually happening in the business today buyers will usually see it.
  3. Being great at running a company isn’t the same as being great at selling it – we have known many CEOs who are great at growing and running their companies but don’t excel at mapping their company’s story into a big organisation and getting potential acquirers really excited.
  4. Be realistic with valuation expectations – I have seen literally tens of millions of value destroyed by companies with value expectations in excess of what the market will pay.  Processes are often launched at the optimum moment for a company to sell and then fail when potential acquirers are told the asking price.  The following year the company is hit with the double whammy of being less hot an of having tried and failed to sell itself.

I might upset some friends with this next comment, but these mistakes often get made because VCs, angels and founders are optimistic by nature, want to believe in their companies and then buy into the stories peddled by their corporate finance advisers.  I am not for a moment suggesting that there is dishonesty at play here, but it is critical to understand how the dynamics between management, shareholders and bankers can quickly lead to inflated expectations of both price and timing and then the other issues listed above.

Reblog this post [with Zemanta]
  • Marc Brandsma

    Step back once and you'll find the 4 almost identical to common fundraising advice (timing, facts, people, valuation).

  • I like the way you blame the bankers (does a political career beckon) 🙂

    Actually, as a former banker, I agree with you, to an extent. Clients hire the banks/advisors who give them the highest valuation. Certain US banks knew this and, for IPOs at least, would put forward the highest valuation and then reduce it massively (sometimes by as much as 50%) in the run up to the deal, citing “market conditions”. This happend so often that we would warn clients of this (naming the bank who was the worst culprit) in most pitches.)

    This is harder to do in an M&A deal and may lock investors, founders and advisors into a totally unrealistic “theoretical” valuation.

    After all, as everyone who hasn't been to business school knows, the only value that matters is the price that someone will be for something.

  • Hi Nic
    Quite agree with your post. One of the problems with price expectations is that when VCs have been hyping a business in their portfolio, they are really reluctant to go back to their LPs and say “Sorry guys, we had this one marked wrong”. So the easiest path – inaction – becomes preferable.

  • Hi Chris – I think the dynamic you describe exists, but people don't 'choose' inaction. Rather they stay with their belief in the upside for longer than they should.

  • I tried to spread the blame 🙂

    All parties have their part to play – the bankers are sometimes at fault for giving credence to inflated exit expectations as 'experts' who regularly talk to market participants. Everyone else is at fault for coming to the big view in the first place and also usually telling the bankers what they want to hear back.

  • The major mistake angel and investors make is not to have a highly probable and well articulated exit going into the deal. I have seen far too many deals where the investors liked the industry, product and people and then wonder why they can't exit several years later. Given that most exits are trade sales, you need to match the product/process with the potential buyers going into the investment. That way you know what to create rather than being distracted by a 'growth' strategy which turns out not to be what the buyer wants.

    You might like to see the book 'invest to exit, which is available free on the Pasadena Angel website for an explanation of strategic value investments where the exit is planned from day one.

  • Thanks for the link Tom, and you are not wrong, a lot of investments suffer for lack of a clear set of buyers. That said, it is tough for people without access to the large companies to know what they will be doing, and even if you have a good idea at the outset there is a good chance they will have changed their minds 3-5 years later.

  • “stories peddled by their corporate finance advisers” — really, in this day and age?

  • I'm afraid so

  • not your decision or something?

  • The board is ultimately responsible, no doubt about that – my point is they should be wary of some of the advice they are getting.

  • i was just wondering if you could change the momentum on paying for such self serving advice. at least sometimes you must be in a position to move things away from the traditional trap.

  • Totally. That is in large part why I wrote the post.