What’s the exit strategy? More notes on thinking like a VC

Posted on October 22, 2009

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One from the Archives (Circa 2001)

Pitching to a VC should be easy.

You’re thinking: Show me the money!

The VC is thinking: Show me the money!

You should be on the same wave length. Chances are you’re not.

You’re thinking about how much money you need today. They’re thinking about how much money you’ll be making for them tomorrow.

You’re thinking about the initial investment. They’re thinking about the rate of return at the end of their investment. (e.g. That’s 1 for you, 4 for me)

You’re thinking about the money you need for your expansion plans and/or new products. The VC is thinking about the exit strategy.

They’re wondering when it comes time to dispose of this risky investment: Who’s going to be buying, what are they buying (e.g. IPO, A part of the action or the whole box and dice), why are they buying and, most importantly, how much will they be paying?

Simple fact is, if you don’t have an exit strategy, you don’t have a promise. If you don’t have a promise you’re wasting everybody’s time. Including your own.

For VC’s, as with all investors, the profit is in the sale.

VC’s are interested in two things. The yield on their investment, also known as the rate of return on the investment, and management fees.

Management fees are what they make out of their investors (e.g. Funds Managers). Investment yield is what they make out of you.

VC’s generally work on a 30% rate of return. So, if a VC invests $1 in you this what they expect to get back when it comes time to sell all or part of the business…

  • Year 3: 2x + the original $1 = $3
  • Year 5: 3x + the original $1 = $4
  • Year 7: 5x+ the original $1 = $5

For VC’s High Risks = High Returns. The longer the risk is held the higher the returns.

Now think about this from your perspective. If you offer the VC 20% of your business in return for $1 and the VC is expecting to receive $4 in 3 years time what should you be expecting to make out of all this? The answer: $17.

  • Year 3: 2*7x  = $14
  • Year 5: 3*7x = $21
  • Year 7: 3*7x = $35

This means the value of your business has to grow from $1 to $21 (+ any taxes) in 3 years.

Now that’s very, very impressive growth but this is what an investment in any innovation strategy is all about. 

VC’s are in the market making lots of small investments in big risks in the hope that some of those investments will deliver big returns in the future. If you are in Corporate Strategic Planning then you are in the same business.

If your company is going to sustain growth in the long term it has to be investing in innovation today. You’ll either be acquiring it or developing it internally. Either way, when the time comes for you evaluate your strategic portfolio, think like a VC.

Look for the projects in your portfolio that will deliver high returns and look for the exit strategy in everything.

The reality is if you’re in strategic planning, and you’re not thinking like a VC, then chances are you’re not thinking about strategy at all.

Other posts on Thinking Like a VC:

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Posted in: Strategic Planning, Venture Capital