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Integrating Business Development with Exit Strategy

Most startups and emerging companies miss the opportunity for an effective exit strategy by not integrating exit strategy into their business development activities. The most likely M&A partner is an existing business partner, especially if you are making the partner successful. By understanding the relationship between business development and exit strategy, you can utilize your partnership efforts to accomplish both objectives.

Startups are often told that exit planning is a dirty word, because investors (mainly venture capital firms) want the startups focused on building the next $1B company. Unfortunately, only 0.07% of the companies make it into this “Unicorn Club”1. Additionally, only 22.5% of venture back companies go public (although that number does seem high)2. The remaining startups are left to contemplate a different future: bankruptcy, M&A exit or stagnation (also known as irrelevancy to your investors looking for a return). Of course, everyone knows that significant amount of investor returns come from M&A exits, which creates a dichotomy between what your investors tell you and the realities that everyone knows. To deal with this dichotomy, startups should integrate an exit strategy into their business development activities.

Without an exit strategy, startups often lose significant value in their exit. The startups aren’t prepared for the worst-case and best-case scenarios. In the worst-case scenarios, companies wake up one morning to realize that their funding is drying up and they haven’t achieved profitability. The inevitable scramble to find an exit ensues. However, the harsh reality sets-in for these companies when they realize that they haven’t built the necessary partner relationships to facilitate an exit. There is a mad scramble to figure out the potential buyers, who is the right person at the partner to execute an M&A deal, and how to pitch an acquisition to each company. Often, companies face the terrible phone call of having to introduce their company to a potential buyer, explain to the buyer why they are great, and explain why they must sell in the next few months. The success rate of such “fire sales” is low, and even if the company can find a buyer, the valuation is usually pennies on the dollar.

In the best-case scenario, when your company receives its first unsolicited M&A offer, you want to reach out to other potential buyers to solicit competing bids. When companies aren’t prepared, they are forced to pay millions to advisors to find other potential buyers. However, if you have done your planning in advance, you should already know who the other potential bidders are and can save significant fees. Additionally, the window for obtaining other bids is often short and other potential buyers are in reactionary mode. The internal process for potential buyers takes time. Many potential buyers can’t respond quickly enough to make a serious competing bid.

To avoid these scenarios, you should integrate exit strategy into your business development activities. With any business development effort, you should start by understanding your ecosystem, including your competitors, inbound partners, alliance partners, go-to-market (GTM) partners, GTM alliances and other partners. As you build your business, you will start forming partnerships with the key players in your ecosystem.

Layering an exit strategy over your business development activities only requires a slightly different analysis of your partners. You should understand (1) your M&A fit to their organization, (2) the rationale for a potential acquisition, (3) the partners M&A history, (4) the “M&A power structure” at the partner, and (5) the key decision makers to know for M&A activities. Once you understand these factors, you will have a roadmap for positioning your company for a potential exit.

1 http://techcrunch.com/2013/11/02/welcome-to-the-unicorn-club/
2 The Venture Capital Cycle, 2nd edition, 2006.

International Expansion Strategy

As startups and emerging companies expand, they inevitably face the question of how to grow in international markets. Too often, companies haphazardly build their international businesses and are frustrated by the results. International strategy requires surveying the market and weighing a number of considerations. A good international strategy will address the following:

Approach

Starting Point: In what region should you start? Traditionally, US companies have started in Europe, and more specifically England, since the market is similar to the US and numerous commonalities exist. Over the last decade, companies have looked at the BRIC countries as the best starting point with the huge growth opportunities in these markets. With the fluctuations in some of the emerging markets, careful analysis is required to assess the best strategy for your product.
Direct or Partner: Should you enter a new market directly by hiring a few local sales people or through partners? The most common path is finding a partner, since partners already have an established customer base and market knowledge. However, for new technology, proper partners may not exist. Additionally, partners may require you to bring them the first few deals to prove there is a market and it is worth their time.
Seal Team Six or Operation Overlord: How should you distribute your resources across the globe? With the global market opportunity, many companies take the “Seal Team Six” approach and send sales people across the globe to win one-off battles in individual countries. This approach can be effective for testing potential markets for your product; however, this ultimately leads to frustration that sales don’t grow exponentially. The opposite approach is the “Operation Overload” (code name for the D-Day invasion) approach, where you marshal your forces to establish a beachhead and back it up with the resources to dominate one particular market. Overtime, you will win the market. However, while this leads to exponential growth in one region, you may be exposed in other regions where the competition may gain traction.

Type of Partner
If you decide to head down the partner path, new sets of strategic questions arise: which type of partnership is best? The typical choices include:

Distributor/Reseller: Traditional distributors and resellers are the easier path. However, many of these companies are “box pushers” and simply fulfill orders. You may be required to handle demand generation, which can defeat your purposes for partnership.
Joint Venture: These are sometimes called “a marriage without love”. Joint Ventures can make sense under certain circumstance; however, they are notorious for misaligned incentives and falling apart after failing to achieve success.
Referral/Independent Sales Rep: Hiring an individual or small firm to land your first few deals is often used. Many times, these individuals are former executives from your potential customer who promise access and influence in buying decisions. These can be effective, but often times the former executive’s influence is less than promised.
M&A: You can always look for a competitor or similar company in the market. If the ideal candidate exists, this can be an effective strategy. You may face difficulty if you buy a company that is not a direct competitor, as you might inherit a product and team that distracts you from selling your product in the market. Also, the integration process can be challenging if not handled correctly.

Choosing the best international strategy will significantly increase your chances of success. Of course, strategies are never effective without good execution. You should tie your strategy and execution together into an integrated approach to ensure you achieve your goals.

When Should You Begin Exit Planning?

Exit planning is essential to achieving maximum shareholder value and ensuring that all your hard work is rewarded. Without an effective plan, market forces or some unforeseen event could leave you scrambling to find an exit. If you sell under distress and without preparation, your valuation will be significantly less.

Exit planning is like an insurance policy. You pay a small amount (of your time and energy) per month to ensure that you are protected against downside risks or worst-case scenarios. Even though entrepreneurs are risk takers by nature and don’t always think about the downside, their friends, family and other investors would certainly appreciate insurance against downside risks. Also, entrepreneurs often don’t realize that their future ability to raise capital may depend on a decent exit with the existing company.

Once you have accepted the need for exit planning, the next question is when to begin exit planning? The answer must be divided into two phases (1) Exit Strategy, and (2) Exit Execution.

Exit Strategy
Your exit strategy should be baked into your overall strategy from the very beginning. In fact, thinking about exit planning from the beginning will help you grow your business. The questions asked during your exit strategy discussions will force you to expand beyond the “comfort zone” of your current business and should create new opportunities.

An example will illustrate this point. Exit strategy discussions start with the basic premise that the most likely exit will come from a partner or someone who knows you. With these partners, the key M&A decision maker could be a variety of different people, including the CEO, CFO, CTO, BU leader, VP or Products and/or Corporate Development. As part of your exit strategy, you will need to figure out who is the M&A decision maker(s), and begin building relationships with these key people. By taking this extra step, you will actually be building a stronger relationship with your partner and may create new business development opportunities by building these relationships. Too often, companies stop at simply building a relationship with middle management, because this relationship is sufficient for your immediate business needs. Thinking about your exit strategy will force you to push further into an organization and to create new opportunities.

Exit strategy discussions will also benefit other areas, such as ecosystem development, financial optimization, customer acquisition strategies and numerous others. These exit strategy discussions will focus your thinking on value creation and how to expand your business beyond its current trajectory.

Exit Execution
The exit execution process should start six months before you desire to have a letter-of-intent (LOI) signed, assuming you are initiating the M&A conversations. Without an effective M&A strategy, the process may take longer. If your M&A advisor must introduce your company to decision makers during exit execution, it can take a long-time to find the right decision makers, get their attention and convince them that acquiring your company should be made a priority (over their other priorities).

Often, companies looking for an exit underestimate the amount of time required to execute an M&A deal. On the seller’s side, you must create all the marketing materials, collect the due diligence materials, and complete numerous other tasks. On the buy-side, time is required to align decision makers around doing this deal, to conduct due diligence and to adequately plan integration.

To avoid the time crunch, a clear exit strategy and a disciplined execution plan are essential to achieving shareholder value.

Growth Strategy

Companies inevitably face the question: how to grow the business outside your existing market? Emerging companies as well as established companies face this question. When a company is started, the best strategy is to focus on a single product and a single market to marshal all your resources towards winning that market. After a few years, you realize that the growth rates of this market and your own growth rates begin to slow.

The chart below provides a high-level framework for thinking about your growth options. Of course, the hardest part about strategy is choosing the best strategy with the highest possible return and the highest probability for your success. Additionally, no strategy is effective unless you know how to effectively execute on the strategy. That said, the first step is to understand the potential growth options.

growth-strategy

Offering Expansion
For product companies, the natural growth option is offering expansion, such as adding support, consulting and other professional services. When adding services, there are a number of considerations. From a financial perspective, services have a different margin profile and business model, and may impact your financial model. From an operational perspective, this requires adding a services organization and usually requires changing internal processes to accommodate the new business model.

Another growth option is to add tangential products and move towards a solution offering, adding different hardware and software. The different solution offerings are usually third party products. Although this can increase revenue, the growth is incremental and doesn’t open up new market opportunities. Additionally, this can have different margin and logistical impacts for the internal organization.

Vertical Expansion
With vertical expansion, companies acquire different partners in the ecosystem or decide to directly compete with these partners. The two most common vertical plays are expanding into the go-to-market (GTM) area and supply chain area.

With GTM, this often happens in foreign markets where you utilize local partners to build a country/regional market presence for your products. You need to decide whether you want to directly enter the market with your own sales force or acquire the local partner. With the supply chain, this often happens when a supplier has high margins and you see the opportunity to reduce your costs by making a competing product or acquiring the partner.

New Market Expansion
With new market expansion, you are looking for new markets to enter that are unrelated to your existing business. Usually, you enter new markets with high growth potential to increase your growth opportunities or to prevent disruption of your core business from an emerging market.

When diversifying into new markets, choosing the best market is always a difficult task. Questions arise around whether the diversification strategy should drive the best market opportunity, the company’s core competency or other factors.

Horizontal Expansion
With horizontal expansion, you are looking for a strategic move in your existing market. Usually, you are acquiring new users through international expansion, for example, or through consolidating the market by acquiring competitors.

Growth in your existing market is usually the best and easiest place to begin growth discussions. Until you are a solid #1 or #2 in your market, expanding into new markets may leave you exposed to competitors if the diversification move distracts you from your core business.

Value Play
Another important consideration in deciding on a growth strategy is to be patient and wait for the right opportunity. You may not have the resources or the market conditions may not be right. You can consider becoming a “value play,” reducing costs and increasing margins while you wait for the right opportunities. The goal is to preserve cash for now and wait for the right opportunities.

Exit Strategy
After reviewing the different growth strategies, many companies decide that exit is the best strategy. Your partners or competitors may be better positioned to grow and expand the business. Understanding the market and competitive dynamics may lead to the conclusion that it is time to exit the business.

Once you understand the different options, it is easier to evaluate each option individually and in comparison to the others. One strategy is not necessarily better than the other. Certain strategies will involve higher execution risk, and should be deprioritized. Additionally, when choosing a strategy, you should remember that the best strategy in the world doesn’t matter if your organization can’t execute on the strategy.

How Risky Is Your M&A Strategy?

Some M&A strategies involve more risk than others. The biggest risk factor is the disruptive change required in your core business. For example, if you are trying to consolidate an industry through multiple acquisitions, then significant risk exists in the integration process. On the other hand, the classic private equity “financial engineering” is less risky. While you are slashing costs, there is no disruptive change happening to the core business. You’re still in the same business and don’t need to integrate different teams and products.

Riskier strategies are sometimes necessary and can achieve greater returns. You can’t avoid shifting market dynamics or other potential disruptions to your business. For example, if you are facing a rapidly declining market and technology disruption, a transformational M&A deal may be your best option.

common-m-and-a-strategies

The above chart categorizes the different M&A strategies from less risk to more risk based on the inherent risks in the M&A strategies. These strategies include:1

Financial Engineering: reduce costs/optimize taxes to increase profitability
Consolidate Capacity: remove excess capacity to fix oversupply problems
Sales Leverage: buy product to sell through your existing sales channels
Buy Tech/Skill: buy new technology or talent
Emerging Market: make small bets with startups in high growth new markets
Defensive Play: buy a disruptor company that threatens your core market
New TAM: buy into a new market to increase your market size
International Expansion: buy competitors in international markets to expand
Consolidate Competition: buy competitors to consolidate the market
Industry Rollup: consolidate a fragmented industry
Transformation: move a company in a new direction via acquisition
Buy Cheap: buy an asset because it is cheap

To ensure that your deal is successful, you should assess the risk factors to understand potential problem areas. If you are engaging in a riskier M&A strategy, you can significantly reduce the risks through an effective deal strategy, including utilizing a Deal Manager with experience in these deals and focusing on value creation throughout the deal process. You can never remove the risk from M&A, but you can achieve success if you understand the risks and diligently mitigate these risks.

1 See McKinsey article for their analysis of different M&A strategies. The five types of successful acquisitions, July 2010 | by Marc Goedhart, Tim Koller, and David Wessels.

Choosing A Buy-Side M&A Advisor

Choosing a buy-side M&A advisor requires deciding what skills and expertise you need to make your deal successful. Most M&A advisors focus on sourcing and structuring the deal, which is logical since most M&A advisors come from investment banking. However, if you want to make your deal successful, you should think about what other skills and expertise you need throughout the M&A deal cycle.

As the chart above illustrates, the M&A deal cycle requires significantly more skill than simply sourcing and structuring a deal. There are numerous areas where your company could utilize M&A expertise. Two examples will illustrate this point:

An M&A target could show signs of significant integration problems. An advisor with skills limited to sourcing/structuring wouldn’t necessarily see these problems, nor are they incentivized to deal with these problems (they are only responsible to get the deal done).
Your internal teams may have limited M&A experience and may not know what is expected of them or how to successfully complete their tasks. An advisor needs to recognize this problem, and have options to address the issue. Ideally, your M&A advisor would have sufficient experience to coach and guide the teams through the process.

These are just two examples of why you should expect your M&A advisor to have experience and expertise across the entire deal lifecycle. Even if you don’t need to hire the M&A advisor for the entire deal lifecycle, this integrated expertise will add significantly more value when you do need them.

When choosing an M&A advisor, you should utilize three basic questions to differentiate the advisors:

What direct experience do they have in each phase of the deal lifecycle: strategy, integration, etc.?
Does your advisor know what it takes to make a deal successful (not just getting the deal done)?
How can the advisor help your teams execute better at their tasks?

These three basic questions should enable you to differentiate between M&A advisors so that you can decide who is in the best position to make your deal successful.

If you want to dig deeper during the interview process, the chart below illustrates how an M&A advisor can and should be an effective Deal Manager. The role of a Deal Manager is to guide a deal from the beginning to the point where the deal achieves its expected outcome. To be successful, there are general skills required from a Deal Manager as well as specific tasks assigned to the Deal Manager at each stage of the deal lifecycle.

The “General Skills” are key attributes and tasks that a Deal Manager should perform across the deal lifecycle. For example, with Collective Wisdom, the Deal Manager should understand why the deal is being done (stated objective), and should track its progress across the deal lifecycle. The accumulated collective wisdom from strategy, sourcing and due diligence will enable the Deal Manager to keep the teams focused on what it takes to be successful and to guide the deal towards successful conclusion.

The “Specific Tasks” are separate from the traditional M&A tasks (valuation, legal negotiations, etc.). These tasks help you identify risks, deal with problems and drive the deal towards success. For example, in the strategy phase, the Deal Manager should quickly identify the riskiness of the strategy and outline a plan for managing these risks during the deal lifecycle (for more information on the risk profiles with different M&A strategies, please see my other article, How Risky Is Your M&A Strategy?).

You can and should expect more from your buy-side M&A advisor. These advisors should have the skill to make your deal successful, not to simply get the deal done.

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