By: Steve Goodman
Every start-up investor dreams of making a bet on the next big thing – the next Microsoft, or Google, or Facebook – and scoring a huge return. The probability of that happening, of course, is minimal. And the risks involved are obviously substantial.
Angel investors and smaller, progressive VCs might find it more attractive to invest in start-ups built from the beginning with a short-term exit strategy. By planning for a successful exit within 18 to 24 months, entrepreneurs can help investors build wealth in a less risky manner. And the strategy works: tech start-ups in the U.S. are showing that there are benefits to this unconventional approach of building to flip.
Why Long-Term Isn’t Always Better
For most investors in technology start-ups, the typical approach entails a five-year investment horizon that will enable the company to build market share and a sizeable customer base, making it ripe for a high-value liquidity event. In fact, this investment thesis holds true for most industry segments. According to a Dow Jones VentureSource report, in 2010 the average age of acquired companies was just over five years.
The problem with this longer-term investment strategy is that, for most companies, getting a sizeable return is a rare occurrence. During the last three quarters, only 15 percent of all deals achieved a greater than 10x return, according to statistics published by Thomson Reuters and the National Venture Capital Association. Another 36 percent were in the 1x to 4x range, with 29 percent achieving 4x to 10x returns.
An investor may miss a critical window of opportunity if the company it funds take the long-term view advocated by traditional VCs. A report by U.S. Venture shows that after two years, a start-up’s valuation begins to decrease as the risks associated with maintaining and managing growth starts to skyrocket. This is particularly true in the U.S. technology market, where the rapid pace of innovation results in a very short period of time during which start-ups offer strategic value to potential buyers.
By investing in a company at the seed stage that is planning an exit within the 18- to 24-month timeframe, the return may be less than what appeals to the average institutional technology start-up investor. But this strategy offers much more in terms of quicker ROI and minimized risk, and gives investors an opportunity to reinvest those gains in hot new start-ups or diversify their portfolio as current market conditions warrant.
What to Look for in a Quick Exit Start-Up
Start-ups that plan to leverage a quick exit strategy must be built a bit differently than companies that are in it for the long run. The goal of the startup is to demonstrate some level of market traction to the acquirer. Investors will need to make sure the start-up’s structure is designed to support scaling the business quickly.
For example, business development should not be aimed exclusively at sales and marketing. Instead the focus must be on building relationships with the M&A executives and key individuals in appropriate business units at larger companies that may be interested in the expanding into market in which the start-up participates.
Importantly, iterations across the functional areas of the business is imperative. Many technology organizations in today’s startups think about an agile approach to engineering – a quick and iterative style to product releases. In the new normal of instant feedback via social media, the same philosophy holds true beyond the development organization. Early, quick failure produces more opportunities to succeed. Business seeking the quick flip should set bi-weekly micro goals that are continually reviewed and challenged. It may appear like a fire drill to some, but for entrepreneurs seeking early exists organizing this chaos into harmony will get to faster results to demonstrate market traction to target acquirers.
Finally, start-ups seeking a quick exit need to engage in strategic PR efforts even before there is a product to push. These campaigns should be designed to highlight market trends, create controversial dialog, and propel brand awareness in order to establish the company and its management as edgy thought leaders.
A company I started called Lasso Logic is one of many start-ups to use the fast sale strategy. Founded in 2003 and funded by angel investors, the company pioneered disc-based continuous data protection technology for the small and medium enterprise market. While focusing on developing its technology, Lasso spent the first months implementing a team tasked with building corporate awareness, and iterating weekly on sales and marketing techniques. Within 18 months of its founding, Lasso Logic was acquired by SonicWALL for almost $20 million – giving investors up to a 5x return.
Lasso is just on example of how you can build a startup and exit in the first 24 months. These companies may not have delivered the huge multiples that are the dream of every investor. But the short-term strategy they employed is a solid one that, if implemented on day 1, can yield a solid profit for investors while minimizing the risk associated with a long-term investment horizon.
Steve Goodman has founded and grown three technology companies to successful exits. He is co-founder of Plum District (backed by Kleiner Perkins and General Catalyst Partners); founder and CEO of Lasso Logic; founder and CEO of Learning Productions, which was acquired by SkillSoft in 2000; and founder and CEO of PacketTrap Networks, acquired by Quest Software, where he serves as VP of the Network Management