If you invest in start ups, one of the things you always want to have a general idea about when you put money in is how are you going to get out? It’s similar to trading. When you put a trade on, you should have some idea of when you will exit.
Of course, putting capital in a seed stage company is a bit different than a trade, but the mentality is the same. Measure the risk/reward ratio, think about how it will happen, do your diligence on the market, and think about the various things that might affect it, then negotiate the deal and put money in. The trade might last seconds, or months. With start ups, you are going to put your money at risk for 5-7 years.
Let’s say things happen and the company makes it. It’s now time for an exit. What will happen?
If you think that you are going to be ringing the opening bell at the stock exchange, think again. Rarely do any seed stage companies go to IPO. Plus, with Sarbanes-Oxley, the incentive is to avoid it. In the old days before Sarbox, there were plenty of smaller IPO’s. Today, the company needs to be worth quite a bit of money to undertake the IPO route.
One trend that is happening is with baby boomers. They retire. They play a little golf and tennis and get bored. The boomers then go into the market and find companies they have expertise with to run. They buy them, run them, sell them and do it again. That’s never really happened much before.
Another interesting trend is with family offices. Family offices mangage money for wealthy families. The typical family office has a minimum of 60 million or more to manage. Their mission is to seek a good return on investment for their clients. As we all know, the stock and bond markets haven’t been the ideal place to see a nice even return over the past decade. The family office is starting to buy up companies.
Family offices buy the company and let management run it. It’s similar to a private equity play, except instead of loading the company up with debt, they try to milk it for the dividends. If they can grow the company they might re-sell it for a profit.
The other exit is typical. Corporations are buying up smaller companies for a variety of reasons. They not only buy them for their intellectual property or market, but many tech firms are buying firms simply to get good talent. Google ($GOOG) has bought hundreds of tech firms just to get the engineers. The engineers work for them on an earn out basis and then leave to start another company.
It’s helpful to begin talking to acquisition partners almost as soon as you start the company. It whets their appetite. If you can get them to talk, listen closely. You will find out a lot about what they are thinking the market looks like in the future and might be able to take advantage. However, be careful about tailoring your company to their exact needs. Those strategies might change, the market might change, and you are stuck holding the bag.