Exit Events

Exit Events

Institutional investors in private companies naturally want some mechanism for getting out the money that they have invested along the increase in value from a successful investment. Therefore, they will usually insist on a viable "exit strategy" before making an investment. Usually the exit strategy consists of one major "exit event" such as an IPO or the company being acquired. Because of the constraints of the conventional funding structure for venture capital funds, there is usually a limited time frame, typically five years, in which the exit event is supposed to be achieved.

Given other constraints, such as the size of the total capital invested and the goal of making back ten times the investment amount, the exit event typically requires the company to achieve a valuation of one hundred million dollars with those five years. Such a valuation is also typically required as the minimum valuation for a good IPO.

However, achieving a one hundred million dollar valuation within five years is a very difficult task even for the most promising enterprises. It is not surprising that, even before the dot com bubble burst, eighty to ninety per cent of the venture backed companies failed to meet this success criterion.

For a company to grow by a factor of ten in five years, it must a a sustained compounded growth rate of over 57% per year. Allowing for dilution from later investment rounds and from stock options, a factor of ten return on an initial investment may require the company to grow at 75% or higher.

There are many problems trying to manage such hyper-growth, with failure not only threatening the growth target but endangering survival of the entire enterprise. The dangers a magnified if the growth is forced from externally supplied investment funds rather than achieved naturally from spontaneous revenue growth.

Extreme Entrepreneurship addresses this problem in two ways.

Firstly, it focuses on the return on investment over a longer and flexible time frame. Secondly, it treats the IPO not as a one-time "exit event," but rather as one event along the life cycle of the company. Extreme Entrepreneurship puts the goal of profitability first. A growing, profitable company has many ways to give a return to investors besides a single "exit event." This increases the flexibility of the time frame because a well run company will continue to grow and increase in value after the IPO.

What are the effects of a longer and more flexible time frame on the expected ROI?

Attempting to force growth of 60% per year produces a very high failure rate. Many of the same companies would survive and thrive with a target growth rate of 30-40% per year. Surprisingly, when the failure rate is taken into account, the return on investment with a target of 40% per year for ten years is not only higher, but nearly double the return with a target of 60% per year for five years. In fact, because the longer time frame allows the compound growth more time to compensate for the failure rate, the return on 40% for ten years is higher than the return on 60% for five years, even when the reduction in failure rate is not taken into account.

On the other hand, most investors would want to start getting their money back in less than ten years. Therefore, Extreme Entrepreneurship supports a "rolling exit strategy." It uses several mechanisms to give an on-going return to investors (and founders and employees) over a period of many years. The returns can start in less than five years and can last for ten years or more. Thus, an IPO, if it occurs, is just one event allow this progression, not a final "exit event."