How to Read a Pitch Deck. Exits
Every fisherman dreams of a big catch, every farmer of a harvest, and every venture investor of an exit
An exit is when an investor sells their share of a startup. In general, the whole point of the VC industry is to have as many profitable exits as possible. That's how we make money in the end. But it is not as simple as we would like.
Foremost, exits are only sometimes successful. And second, you should have infinite patience and perseverance, because it takes years for a startup to pay off. In this article, we'll explain why you need exits, and cover their main types.
Many thanks to TA Ventures principal Elya Checheneva for her help in preparing this article.
The (non) Comfort Zone
Many readers might ask the logical question: why sell your share and walk away from the company in the first place? After all, if the startup is consistently bringing in money and everything is going well, isn't it better to leave things as they are? Investors have three main reasons to exit sooner or later.
To begin with, VC funds have obligations to their partners, whose money they manage. The partners expect returns in the foreseeable future and within the agreed timeframe. These rules of the game keep funds on their toes, pushing them to actively sell assets in the most profitable manner.
It's important to remember that in the short term, no amount of operating income can compare to the amount of money generated from exits. For us, waiting a few years to make money is more of a necessity. If we had our way, we would be selling assets every month at a high price.
Then there is risk management. Just because a startup is doing well now does not mean it will always do so. Investors regularly analyze internal and external factors to determine the best time to exit. It is not uncommon for dark clouds to hang over specific industries or companies. In such a scenario, it is better for investors to make a decent exit now than to wait and face a crisis. Risk management also applies directly to the third point below.
Funds need money to invest, and they make money from exits. In other words, it is an operating expense. The money earned is invested in subsequent startups. This is how we diversify our portfolio and multiply investments. More promising companies in the portfolio mean a higher chance of success. But in order to invest in the second and third startups, you first have to get money from the first one.
As you can see, staying in startups for too long is not an option. Investing requires constant motion. Now let's look at what types of exits exist.
Types of Exits
Secondary Market. A classic of the VC industry and the most common exit option when investors sell their stake to other investors. Typically, such an exit occurs when the startup raises a new round. Technically, however, it is possible at any time.
When a startup attracts new investment, it is always accompanied by increased interest from players in the market. And when that happens, we have a good opportunity to offer assets at a bargain price. We do this for several reasons.
Maybe the startup has already paid for itself, and we have received the originally planned 5x. It is also possible that investors are skeptical about the company's future and want to exit early.
In addition to these two scenarios, investors may be concerned about the dilution of their shares as the number of holders increases with each new round. Another reason is the fund's strategy itself. For example, TA Ventures specializes in the early stages, so when a company moves to the later ones, we tend to make an exit regardless of its success.
Mergers and acquisitions (M&A). A company buys some or all of another company to gain control. These deals happen for a variety of reasons. For example, to enter a new market, to reduce competition, to obtain innovative technology or intellectual capacity, i.e., a team.
There is even an investment strategy where startups are founded specifically to be sold to big enterprises. This is a known story in the deep tech sector. Here, startups may show little or no revenue for years, but they are of interest to corporate giants.
One of the less obvious benefits of M&A is that it can be used to get rid of distressed assets. With a healing discount, investors may be able to sell the startup or parts of it (the technology, the team) to the corporate sector to break even. For other investors, such assets are of no interest, while the business can use them for its own needs.
Going public. The culmination of the investment and the most coveted exit option that funds take great pride in. The startup's shares become available to public investors. Surprisingly, this high point has as many advantages as disadvantages.
On the one hand, a startup's capitalization can increase tens, if not hundreds, of times. The influx of new investments multiplies your own, and shares grow like mushrooms after the rain. However, the company's publicity also makes it vulnerable to everything. Press, market conditions, tendencies, or just bad luck. There have been cases where going public has only hurt companies and investors.
For the sake of background, let us mention the options for going public. There are three:
SPAC. An “empty” public company is created to take over a startup.
IPO. The startup sells shares with the help of underwriters.
Direct. The startup sells the stock on its own.
Going public is a long process and rare. The vast majority of startups, as well as investors, are not destined to make it. In more than ten years, our fund TA Ventures has completed six IPOs. That's out of more than two hundred investments.
“Negative” Exit
Making an exit doesn't necessarily mean making a profit. Any of the types of exits described above can be a success or a failure. You can go into the stock market and the stock goes down instead of up. The plan was to make 10x, and we came out with 2x at best. The worst is bankruptcy. Unpleasant, but unfortunately, an inevitable phenomenon in the world of VC investing.
In the event of bankruptcy, in most cases, investors do not receive any payment or compensation because they are shareholders, not creditors. Be that as it may, it is impossible to achieve a 100% success rate here. The main thing is to make sure that the profits from the deals exceed the losses. For every ten loss-making startups, there may be one super-profitable one that covers all the costs. Most of the time it’s just like that.
Different startups take different amounts of time to exit. This characteristic depends on the industry, the product, the global macroeconomic situation, or just plain luck. The median estimate is 5 years. Some startups may remain in the investor's portfolio for up to 10 years. The strategy of our fund TA Ventures, for example, assumes an average payback time of 4–5 years.
From the Editor
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