It’s So Hard To Say Goodbye: The Exit Strategy

April 29, 2011
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Parting is such sweet sorrow when building a company from infancy and then letting go to see it spread its wings.  Planning a proper exit strategy is crucial and not just when referring to love and war.

Parting is such sweet sorrow when building a company from infancy and then letting go to see it spread its wings.  Planning a proper exit strategy is crucial and not just when referring to love and war. The perpetuation of ownership and the succession of management are among the most difficult challenges that a privately held business will ever encounter. The decisions surrounding these issues will determine what will become of the organization to which business owners have devoted their lives, and what will be the return on what is likely their most valuable financial asset.

Yet, ironically, these critical — and complex — decisions are among those for which the owner is least prepared, since they may be confronted only once in a lifetime. Owners may have many decades of experience at managing a business, but little or no experience with the monumental task surrounding his or her exit.

Acquisition is one of the most common exit strategies: You find another business that wants to buy yours and sell, sell, sell. In an acquisition, the seller negotiates price. This is good. Public markets value a company relative to its industry. Who wants that? In an acquisition, the sky’s the limit on your perceived value. The person making the acquisition decision is rarely the owner of the acquiring company, so they don’t feel the pain of acquisition cost. The goal is to convince a buyer of the company’s worth.

How do you select the right company? Look for strategic fit: Which acquirer can buy you to expand into a new market, or offer a new product to their existing customers? But acquisition has its dark side. If there’s a bad fit between the acquirer and acquiree, the combined companies can self-destruct. The acquired management team can end up locked into working for the combined company, and if things head south, they get to watch their baby implode from within.

For the owner, the idea is to make yourself attractive to acquisition candidates, but don’t go so far as to cut off your other options. One software company knew exactly whom they wanted to sell to, so they developed their product in a way that meshed perfectly with the prospective suitor’s products. Too bad the suitor had no interest in the acquisition. The software company was left with a product so specialized that no one else wanted to buy them either.

Pros

  • If you have strategic value to an acquirer, they may pay far more than you’re worth to anyone else.
  • If you get multiple acquirers involved in a bidding war, you can ratchet your price to the stratosphere.

Cons

  • If you organize your company around a specific be-acquired target, that may prevent you from becoming attractive to other acquirers.
  • Acquisitions are messy and often difficult when cultures and systems clash in the merged company.
  • Acquisitions can come with noncompete agreements and other strings that can make you rich, but make your life unpleasant for a time.
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Jeffrey Bacha, President and CEO of Del Mar Pharmaceuticals, contends that there is a “right” and a “wrong” time to exit via sale/acquisition. “In my view, value inflection points are a logical point to consider an exit.  For example, Del Mar Pharma is currently focused on one lead asset, VAL-083.  We’ve recently filed an IND and are in the process of initiating a Phase II clinical trial.  Based on positive data, we would be seeking to raise significant capital to support a registration-directed clinical study about 12-15 months following initiation of our current study.  At this point, we’d look long and hard at raising sufficient funds to commercialize VAL-083 and to build a product portfolio behind our initial drug candidate; however, we would also be ripe for acquisition by another company as a way for them to access a clinically validated late-stage product candidate.”

He continued, “We can point to two examples (Salmedix & ChemGenex), where the North American rights for the resurrection of an “old” drug in a modern orphan cancer indication have been valued at approximately US$200 million.  In both cases, the company developing the new drug was targeted for acquisition prior to FDA approval.  While acquisition is a likely exit scenario for Del Mar Pharma, our focus on orphan drug indications provides a realistic opportunity for investor exit through organic growth and a public listing.  By developing and launching products targeted at orphan drug indications, we’re potentially positioned to achieve profitability and positive cash flow by directly commercializing products through a small-focused sales force.”

While he wouldn’t comment on any current plans to exit, he did admit Del Mar has received meaningful attention. “Of course we are always open to a potential transaction in our approach to corporate development.  In my view, building our company is a series of ‘make vs. buy’ decisions.  As we go forward, we would take any opportunity to have our assets included in another company’s development portfolio at a fair valuation very seriously.”

The IPO. An initial public offering, or IPO, is the first sale of stock by a company to the public. If a company is well funded by professional investors with a track record of taking companies public, the owner might be able to do it. Of course, the professional investors will also have diluted the owner down to the point where he only owns a tiny fraction of the company anyway. The investors will make out great. And maybe, if the owner is the principle entrepreneur and has done a great job protecting his equity, he’ll make some money, too.

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You start by spending millions just preparing for the road show, where you grovel to convince investors your stock should be worth as much as possible. Unlike an acquisition, where you craft a good fit with a single suitor, here you are romancing hundreds of Wall Street analysts. If the romance fails, you’ve blown millions. And if you succeed, you end up married to analysts. Once public, you bow and scrape to the analysts who more than likely will study your every move. Then there are the 6 percent underwriting fees you’ll pay to investment bankers, lockout periods, or how down markets can tank your wealth despite having a healthy business, or how IPO-raised funds distort your income statement.

Pros

  • Exposure, prestige and public image. You may be on the cover of Newsweek.
  • Your stock will be worth in the tens–or maybe even hundreds–of millions of dollars.
  • Bolstering and diversifying equity base
  • Enabling cheaper access to capital
  • Facilitating acquisitions

Cons

  • You’ll spend your time selling the company, not running it.
  • Investment bankers take 6 percent off the top, and the transaction costs on an IPO can run in the millions.
  • Ongoing requirement to disclose financial and business information
  • Public dissemination of information which may be useful to competitors, suppliers and customers

In short, IPOs are not only rare, they’re a pain in the backside. They make the headlines in the very, very rare cases that they produce 20-year-old billionaires. But when you’re founding your company, consider them just one of many exit strategies. Realize that there are a lot of ways to skin a cat, and just as many ways to get value out of your company.

Antoine Papiernik, Managing Partner at Sofinnova, and advisor to OneMedForum NY 2011, could speak on the subject for hours but sums it up by saying, “On the principal that “nothing is more expensive than what is not for sale”, my view is that the best exits come to companies that are not (at least not officially) looking for it. The second you have an exit process in place in absence of an initial buyer interest, the result is going to be sub optimal. You’ll know it is time to sell when several buyers line up to buy. But then of course you need to be prepared. Exits only come to those that have planned carefully their business in such a way that buyers will be drawn to them. One important thing is to make sure the various stakeholders (management, board, investors) are aligned to an exit. If a CEO’s incentive is not aligned, for a number of reasons related to his compensation (his stock is underwater, the liquidation preference of the VCs are creating a cliff, etc etc), then he (or she) will resist a sale, and the board may never see it.”