Liquidity or exit planning typically gets put on the back burner until it isn’t—and then a mad scramble ensues. It’s a topic that can be taboo, stemming from optimism bias or a steadfast commitment to staying the course as an entrepreneur. 

Proactively preparing for a potential liquidity event brings many benefits, even if it doesn’t occur. It builds organisational maturity, helps identify operational improvement areas, offers founders the broadest slate of options and prevents a last-minute clamber when an unexpected deal or need for urgent liquidity arises.

In a recent portfolio executive forum, we covered exit planning with the help of Paul Perrett and Scott Colvin. 

‍Paul is the Co-founder and co-CEO of Firmable, a Strategic Advisor at Vitruvian, and the CEO of MessageMedia (acquired for $1.7bn in 2021) and COO of Aconex (acquired for $1.6bn in 2018). 

Scott is the Founder and Managing Director of Blackpeak Capital, an independent corporate advisory firm based in Sydney. Scott and the broader Blackpeak team have extensive technology and software deal experience having completed over 50 transactions across IPOs (WiseTech and Audinate), private growth rounds (Data Zoo and Studiosity), sell-side exits (Education Horizons and Instaclustr) and public M&A (Xero and Wisetech). 

In this article, we’ll cover:

• The most common liquidity pathways
• How to identify your most likely exit or liquidity pathway
• What a typical exit process looks like: perception vs reality
• How to set yourself up for success

In future articles, we’ll cover the mechanics of the exit process and some tips and benchmarks for appointing advisors. 

Overview of liquidity and exit pathways

Secondary sell-down

Secondary sell-downs are sometimes available alongside growth equity or pre-IPO rounds, allowing founders, early investors, and, in some cases, early employees to take some money off the table in addition to raising primary capital. This enables founders to:

• Refresh their shareholder base with later-stage investors with the skills and experience suited to the company’s next stage of growth. These investors typically have longer-term investment horizons, which can reduce the pressure on the company to achieve near-term liquidity and; 
• De-risk their financial position and focus on driving business growth. 
• Existing and incoming investors are usually supportive of founder sell-downs once a business has reached a certain inflection point, but this is typically limited to <20% of their holding and a few million dollars max.

‍Examples of companies that have completed secondary sell-downs alongside growth or pre-IPO rounds: Canva, Pet Circle and Employment Hero.

IPO

While ringing the bell and becoming a listed CEO is what you see in the movies, an IPO isn’t a feasible (or desirable) path for all. Size, scale, revenue predictability, profitability and management capability are paramount considerations for IPO readiness.

Examples of companies that have IPO’d: 

• ASX: Siteminder, Xero, Afterpay, WiseTech Global, Aconex
• NASDAQ: Atlassian, BigCommerce

Acquisition

For many startups, an acquisition (or control transaction) emerges as the most probable liquidity pathway. Acquisitions fall into two main buckets:

• Financial Sponsor: Sale of a majority stake (>50%) to a financial investor such as a private equity firm (e.g. AKKR, Riverside, Potentia, Vista) 
• Trade sale: Sale of 50-100% of the company to a trade/strategic buyer or PE-backed strategic. 

‍Examples of companies that have been acquired: 

• Financial Sponsor: Uptick (Acquirer: AKKR), Rezdy (Acquirer: Vertica Capital Partners) PageUp (Acquirer: AKKR). 
• Trade Sale: A Cloud Guru (Acquirer: Pluralsight [Vista Equity Partners]), Message Media (Acquirer: Sinch), Xplor (Acquirer: TSG [Advent]), Ento (Acquirer: Humanforce [AKKR]), Nura (Acquirer: Masimo) and Elevio (Acquirer: Dixa). 

To understand which is most relevant and suitable for your business, you’ll need to work through the key considerations in the next section.

Thinking through your options 

Understanding stakeholder objectives

A successful exit starts with aligning stakeholder objectives on sell-down percentage, liquidity timeline, and valuation expectations. Additionally, defining founder and management roles post-liquidity event also influences exit paths. Founders, management, boards, and investors must clarify their distinct goals and priorities upfront to help establish the optimal liquidity pathway.

Consider market conditions

Market conditions play a significant role in shaping exit options. The IPO market, for instance, can be effectively “closed”, particularly for <$1b listings, due to public investor sentiment and economic conditions. Being mindful of these market nuances can influence the timing and feasibility of different exit pathways.

Business scale and maturity 

The scale and maturity of the business influence potential exit pathways. Factors such as absolute revenue size, revenue predictability, geographic footprint, and addressable market size impact the available options. The depth and experience of the management team and the robustness of your systems and processes are added layers of maturity needed to successfully IPO. 

Growth vs burn profile

Your business's growth and profitability profile heavily influences the universe of potential investors and buyers. As the name suggests, growth investors tend towards ~30%+ growth, while private equity investors typically need profitability to leverage their investments with debt.  

Partnering for value creation

In some cases, partnering with a strategic investor or acquirer can unlock additional value and capabilities. Collaborating with a partner can expedite global expansion, provide operational expertise and enhance market competitiveness. 

Liquidity and exit pathway considerations

The tl;dr–Due to the range of potential buyers, feasibility and fit for startups, an acquisition will be the pathway for most businesses. Secondary sell-downs alongside a primary growth round are possible along the way, but size and scale are important. IPOs are typically reserved for larger companies with solid visibility on forward revenue streams and a management team ready to operate in the public market.

Planning for an exit

The adage “Companies are bought, not sold” rarely matches reality

“We often get companies coming to us and saying they want to run a process immediately, or they’ve had an approach and need to close the transaction within three months. That’s unlikely to work and won’t get the right outcome for the founder, stakeholders or shareholders,” says Scott. 

Successful exits are years in the making and involve extensive preparation and engagement with potential buyers or investors. 

A “strategic review” is a good starting point when planning for a liquidity event to align stakeholders and position the business for an optimal outcome.

Strategic review

A strategic review serves as a valuable step in exit planning, typically with the support of an advisor, to conduct high-level financial and commercial due diligence, a comprehensive analysis of your metrics and an exploration of the board's and stakeholders' objectives. 

The review typically spans 2-3 months and frames up potential strategic and capital options so the board can make informed decisions on exit planning and understand key value drivers ahead of an exit event. As part of your annual strategy-setting process, this is a good exercise to do internally anyway. Outcomes and insights gleaned from the process can influence everything from your product roadmap to your partnership strategy, among other things.   

Early engagement with an advisor can help you gain insights into relevant market data points and benchmark your operating metrics and valuation against industry peers. 

“Founders should start educating themselves early on about valuations and develop a bank of transaction data relevant to their business,” advises Paul.

Preparing for an exit

Even if an exit event seems far away for your startup, it’s never too early to start preparing. Here are some practical and actionable things you should do as part of your BAU to ensure you’re on the front foot when it comes to exit preparedness.

Know your market

Develop a deep understanding of your market landscape, including total addressable market (TAM) and serviceable market (SAM) by segment. Stay updated on market trends, competitor activities and factors that differentiate your offering. Articulating why you win against competitors is essential for demonstrating value to potential buyers or investors.

In practice:

• To include in your Management and Quarterly Board packs:
  • Market and competitor updates, including product & pricing changes, fundraises, regulatory changes
  • Win / loss analysis by segment, including why you win vs lose and to whom
• To include in Annual Strategic Planning:
  • Market size by segment (ideally built up by ICPs/pipeline)
  • Market size potential with analogous examples vs traction-to-date
  • Adjacent opportunities/growth vectors, plus how and when to attack

Know your business

Equip yourself with robust management and board reporting mechanisms and get a good grip on your metrics and how you benchmark.

“You’ve not only got to know your metrics, track them, and be able to reproduce them, but understand how people are going to look at them and how they relate to your business model,” says Paul.

For example, say your business is highly transactional, digital inbound, with low CAC but high churn. You’ll explain how your business works and that your churn is slightly higher because you operate in the SME market. Your great customer acquisition economics offsets the higher churn.

In practice:

• To include in your Management and Quarterly Board packs:
  • Historical and forecast 3 statement financials and key metrics/drivers
  • Cohort/retention analysis and segmentation
  • GTM efficiency and pipeline coverage
• Up-to-date cap table and ESOP schedule

Cultivate relationships

Develop relationships with commercial partners, investors, advisors and competitors to help identify potential investors and acquirers, bolster credibility and trust, and gather market intelligence. 

In practice:

• Map out upstream and downstream partners (i.e. most likely acquirers)
• Develop relationships with internal line sponsors at key strategics. Understand their pain points and how your business can help. 
• Regular check-ins with financial investors to update on progress (in-person is best)
• Leverage 2-3 trusted advisors for market intel, counsel and potential support with your “Strategic Review.”

Build internal capability

You’ll want to get your backyard in good working order before entering any fundraise, let alone an exit process. Evaluate your management team and identify gaps, particularly in often overlooked areas like finance. Many businesses, even when they’re approaching $15-$20 million in ARR, continue to outsource this function. Investing in a strong CFO or head of finance can bolster your understanding of your business, ensure sound financial fundamentals, and streamline the exit process. 

In practice:

• Leadership team present at quarterly board meetings
• Develop key people or hire to plug gaps (e.g. GTM, Product, COO)
• Invest in your finance function:
  • <$5m ARR partner with the right virtual CFO and investors
  • >$5m-$10m ARR= hire a Head of Finance/CFO

Key takeaways

1. Successful exits are years in the making. They start and end with good planning and preparation.
2. Determining your best exit pathway begins with understanding your stakeholders’ objectives, market conditions and how your business is tracking.
3. M&A is the most likely path. Secondary sell-downs and IPOs are typically reserved for larger, scaled businesses. 
4. Exit processes always take longer than you think.
5. Take action now! 
   • Stay abreast of market and competitor moves.
   • Embed operational best practices into BAU.
   • Develop relationships with partners, investors, advisors and competitors.
   • Level-up your team.