Tuesday, October 1, 2013

The Exit Slide

In the “angel pitches” I see in our meetings, the Exit Slide seems to be frequently a weak part of the presentation. This is unfortunate because the Exit constitutes the major determinant of the pay off that investors may expect.  Why? Because investors typically do not see any return of, or on, capital until the Exit. The valuation of the company when sold will determine the pay out. The IPO case, most likely farther away in time, is much the same as the market valuation would reflect similar considerations.  Let’s focus then on the M&A Exit.

The following discussion involves many generalizations. As with most generalizations, countless exceptions can be found.  However, investors rely on these generalizations particularly to form first impressions in their due diligence. A wise pitcher, then, should be aware of those perspectives and speak to them.

Apart from strategic considerations unique to the acquirer, the M&A valuation of the venture being acquired will reflect the growth rate in sales and earnings (or reduction of losses) as prognosticators of future profitable growth. 

Moreover, the valuation will also reflect some multiple of annual revenues, which number correlates with other companies in the same industry. The correlation exists because that multiple reflects each industry’s underlying fundamental risk.  Some examples:
Rapid scaling of a software, or cloud-based, product or service is relatively easier than scaling a business that requires heavy capital investments. Similarly a line of “fashion” products that depend heavily on the company’s design guru to hit the sweat spot of unpredictable consumers carries inherent risks.  
Ski manufacturers live in a very competitive and concentrated market where product performance is difficult for consumers to measure (few can try before they buy) and where the appeal of the graphic design and style can make or break a sale. This complex and unfavorable state of affairs is reflected in the revenue multiple that applies to most M&A in skis and sporting goods: 1X. That multiple, in essence, says that acquiring companies give a low probability of repeatability of profits' growth. Conversely, medical devices valuations are in the range of 3 to 5 and even 10 times revenues, which reflects that, most often, once they gain traction, they have patents to protect their markets and margins, and can grow more reliably.

To make the case for your venture's projected valuation at the time of exit, present the following
  • A few examples (3-4) of recent acquisitions in your space showing names, valuations, revenues and resulting multiples in each case.
  • Show an average, perhaps adjusted for outliers or special cases.
  • If acquisitions of companies like yours do not exist (seldom the case) use the closest proxies you can reasonably find
  • Using the data above, make a supported claim of your valuation under similar circumstances based on the revenues projected at time of exit
  • Calculate the investors’ projected return based on the % of your business that you offer to trade for the desired funding. Note: This simple extrapolation works if you project a single funding event to take you to the exit.  If future rounds are contemplated, you have to adjust the analysis for dilution from those events.
  • Do not explain the logic in the slide, do that verbally. The slide only summarizes the data the audience needs to follow your explanation.
 Note:  My post AngelCalc elaborates these concepts further and includes a working calculator to do the math for you.  Be sure to understand the use of the factor “Probability of success” as it reflects the maturity of your venture.  If pre-, or nominal revenue, probably no adjustment is needed.  AngelCalc can also be a test for the attractiveness of the terms you offer vis-à-vis investors’ likely expectations.

Marco Messina