Strategic Execution Part 3.6: Exit
This blog is part of a series of blog posts on the 6 stages of corporate development with the overview here. In previous blog posts, I explained what strategy is, why it is needed, and how it is developed and executed; at least in a reference process for a growth stage company. In this post, I will outline the final of six stages of strategic corporate development for growth from inception to Exit; mastering the highly differing and even contradictory demands and focuses of each of these independent stages is the key to successfully navigating the entire journey.
The Exit stage is the stages during which the founders, investors, and stakeholders along the way will harvest the value they have helped build over the life of the company. It is also, often, the beginning of a new life for the company with new direction, resources, and capital. This stage consists of preparation, the transaction, integration, and post-merger operations. The objectives should be tailored to the goals and interests of the founders and subsequent stakeholder investors. In most cases, maximizing value extracted is the key objective; other considerations may include the landing for key people and teams that the founder has built, as well as perpetuation of brand and reputation. The most important thing to remember for founders is that Exit looks very different for founders and investors for two key reasons. The first is that most Exit transactions tie founder’s equity to the successful integration and post-merger operation and the second is that, depending upon how the company’s value has been built, investors often have liquidation preferences and other terms that may divide the company’s value unequally.
The first thing to note is that the objectives of Exit are not always the same:
Maximize the value received for the business both through the transaction and as founder’s value is actually extracted (most common)
Create a career transition for founder’s and key personnel into the new business (possible)
Protect the teams and people who helped build the business (possible)
Protect the legacy of what has been built (possible)
Exit Key Metrics:
Key Metrics for Exit varies by sub-phase.
During the preparation and into the transaction phase, the key metrics are the growth stage KPIs the company has been using, with specific attention to hitting predictable growth, profitability, churn, and free cash flow. Maximizing the value obtained for the company.
During the integration phase, the key metrics will relate to the objectives of the integration plan. These usually relate to key personnel retention, intellectual property security, avoiding process disruption, and customer relationship management.
Once the post-merger operations begin, the key metrics will transition over to the KPIs for the new strategic plan, whether for the new independent entity or the entity as integrated and now a part of the strategic plan for the larger organization.
Exit Areas of Consideration:
Exit should be viewed as a stage rather than as an event; it is a sequence of changes and actions. For founders and other key personnel, it can last for many years or be shorter. Looking at each of the elements of the stage independently of preparation, the transaction, integration, and post-merger operations, I will share some areas of consideration for each of the elements.
It makes sense to perform a brief review of the Exit pathways that exist for most privately held companies:
Initial Public Offering (IPO): Here, the stock of the company is offered in the public markets and the company will continue as a public entity. Sarbanes Oxley and other regulations have made this option less attractive in the last decade for most private companies, but there are circumstances where it is the right answer. The value of the company is determined primarily by its financial performance and potential along with public market perceptions and trends.
Financial Holding Company: Here, the stock of the company is acquired by a financial holding company for continued operation and generally will not be integrated, though management and growth practices may be levied down to the company’s management. The value of the company is determined primarily by its financial performance and potential.
Strategic Acquirer: Here the stock of the company is acquired by an operational company that sells products and/or services purchases the stock of the company in order to integrate operations (generally), product, and service offerings. The value of the company will be determined by a combination of its financial performance and potential and its perceived upside potential to enhancing the financial performance of the acquirer.
Private Equity Acquirer: here a private-equity backed operational company and team that are pursuing a well-defined investment thesis acquire the stock of the company. The acquisition may be viewed either as a platform or as a strategic add-on. In the former, the value of the company is determined by its financial performance and potential, specifically its ability to carry strong debt leverage through EBITDA production and operationally perform as a platform for augmentation to fulfill the investment thesis. As a strategic add-on, the value will primarily be determined by a combination of the financial performance and potential as well as a heavy emphasis on the potential to improve the financial performance of the platform company.
Asset sale: Here the company will be broken up with specific assets sold to potentially different acquirers. This can be a part of one other types of Exits to shed risk-bearing or non-critical assets, or it could be the only opportunity for liquidation given poor performance of the operations of the company. In the latter case, the company may be wound down after a sufficient number of assets are sold. The remainder of this section will focus on Exit as a sale of the equity.
Planning for Exit should really begin during Company Launch and constantly updated and revisited during the life of the company. The key activity to focus on as Exit timing draws near has to do with operational consistency and identifying the best transaction opportunities. Operational consistency is important because the ultimate value derived for the business is always dependent, at least in part, on the free cash flow being produced by the business (whether turned into growth, used to improve the business, or accumulated as cash) including the reliability of that cash flow. How that free cash flow should be purposed prior to Exit varies by industry, company type, and market conditions. There are circumstances where the best value comes from driving growth and producing zero or negative EBITDA right up to the transaction and there are conditions where that would be entirely inappropriate. Looking at industry trends, financial markets, and speaking to a variety of potential acquirers in the early stages can help vet out which type of transaction is best for and most likely for the company. The mechanics of preparation should be obvious. As with each capital raise, the transaction will be accelerated by having a data room ready to support acquirer’s due diligence before the first serious discussion. Just like with each capital raise, the executive team and board should review the enterprise’s risks and issues and resolve where appropriate, independent of the decision to acquire reps and warranties insurance.
I will not delve into the transaction itself in detail, as there are number of good resources on negotiation preparation, vetting potential business partners, and game theory in conducting the negotiation itself. These are likely appropriate for preparing for any capital raise as well. There are a number of important points for managing the company during the transaction itself that are worth pointing out. First, keep running the company and keep the transaction and daily operations separate. It is critical for a CEO to build a management team around them that can run the company without much intervention from the CEO to make this work. The CEO and CFO will be most involved, with select top executives involved as needed. Ensure secrecy of the transaction is maintained, but be ready to address the transaction being leaked to employees, suppliers, and customers as this may happen. Ensure that a rapid integration plan is prepared that addresses key personnel retention, IP protection, business continuity through the integration, relationship retention, and any other key items specific to the integration.
When the day comes for the acquisition announcement kickoff of the integration, the most important thing to remember is that large number of participants in the process may be stunned into inaction; including possibly yourself and other members of the executive team. The first thing to address is always the personal and the key is to be able to address how this change affects each person recognizing that such change always breeds a great deal of fear. Good planning and attention to taking care of people to a reasonable degree makes this possible, but must be followed by swift action. Integration of operations, processes, systems, and daily activity can and should proceed on an orderly plan after that. Settling the key issues of people, relationships, and IP first will build a foundation that enables the team to focus. I will write a separate future blog post on M&A integration and other facets of M&A.
Post-Merger Operation is the period during which founders may find themselves in operational / management roles within the new entity that resulted from the acquisition. This period may last through the completion of the integration or beyond. It is common for stock from the acquired company to be converted to stock of the acquiring company and for additional stock transactions to be restricted for some period. In some cases, it may also be desirable for the acquiring company and one or more of the founders or key personnel to maintain their role into the future. In either event, these minimum holding and operations periods are there to ensure that the value purchased is retained to the extent possible through careful shepherding of the integration and operations, that the new executive team learns what is needed about the new company, and that any risks, misrepresentations, and issues are identified and settled as appropriate.
What stage of corporate development are you currently in and what challenges are you facing?
For most companies, the usage of external parties to facilitate the strategic planning and execution process produces superior results. The process typically involves a great deal of information processing that isn’t core to running the business on a daily basis and a facilitator in planning sessions frees up the team to focus on the critical questions rather than the process and can inject highly productive objectivity into the discussion and decisions. If you would like to discuss where your company is in the evolution of strategic planning and execution or would like some assistance in setting up or performing this critical process or just have a question please contact us.