Note: This article is part of a series on how entrepreneurs should address trick questions from investors.
If you read my article on five pitch mistakes that will quickly land you in the “No” bucket when fundraising, you understand why investors make impulsive decisions. The smallest imperfections or mistakes are compounded. You get one chance to make a first impression.
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You can control your pitch, but you can’t control the questions. While most questions are transparent, some have hidden agendas. “Close your laptop. Why should I invest in you?” Do investors really care about the actual answer? Kind of. But this is really part of the “does this person have the right stuff” algo that started running the moment you walked into the office. So this is more of a pressure test. This is about your reaction. Got that deer in the headlights look? Game over. Other questions, however, are far more subtle. In this series of articles, we are going to address several questions and topics that trip up founders and CEO’s during the fund raising process. Let’s start with a perennial investor favorite.
What’s your exit strategy?
Seems simple enough. At the end of the day, we are all about a great return for our investors, right?
The typical response sounds like: “Our platform aligns perfectly with major players like Google and Apple. Apple actually bought a competitor company Worse-Then-Us, Inc. for $300M last year and our tech crushes them! We believe the milestones we will achieve in the next 2-3 years will position us for a high value take-out or an IPO.”
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Please do not mix in words like disintermediate, disrupt, game change, transform, or revolutionize. And yes, most investors can actually see the thought bubble over your head that reads, “and then my decision will be whether to get the baby blue or the hunter green Ferrari.”
For starters, remove “IPO” from your vocabulary. Guess how many digital health companies did an IPO in 2017? Exactly zero. According to Rock Health’s 2017 Year End Report, “For now, at least, M&A is the new digital health IPO.” If you are still not convinced, the average digital health company that did an IPO took 10 years and raised $167 million, according to the same Rock Health Report. And an IPO is not a short-term exit, since most investors and employees have lock-up periods that prohibit the sale of their stock for months to years.
Here’s the bigger problem. When you jump right to the sale of the company, this tells investors you are about the money and not the mission. So what? As long as we make money together, all good, right? I mean, you just showed projections that suggest your investors will be getting 5x-10x return! Not a chance. Early stage investors know the road ahead is long, difficult, and loaded with minefields. You are going to smash into a few, guaranteed. And when you do, if you are all about the money, you are a flight risk. Said another way, when your car careens into a wall, are you going to pick up the burning embers with your bare hands and put it back together, or are you calling an Uber?
A far more powerful response that gets investors excited sounds like:
“Our team is passionate about building a great company that will [insert compelling problem and solution statement — see my prior article on the topic]. Once we scale in our initial target market, we have a clear vision supported by a cohesive plan for addressing many other large market opportunities. Today, however, we are laser-focused on execution and scaling in our initial market. Once we have customers that love us and deliver rapid sales growth, we are confident that an acquirer will see tremendous value in what we have built. But right now, we are focused on delivering value and a great experience to our customers! ” Kaboom!
Liquidation events are like exit ramps on a long highway journey. The mile markers are like milestones. As you pass certain mile markers, exit ramps will appear. You (and your Board) then have the luxury problem of deciding whether to continue the journey of creating more shareholder value or taking the exit. If you are all about getting to the first exit as fast as possible, you are, by definition, not in it for the long haul. Investors are backing a team with a vision we believe in, and when we are right, a quick exit usually does not maximize value.
Now before all the new age pro-exit pontificators jump in, I am not saying don’t think about your exit. In fact, you are always planning for the exit. As a founder or CEO, you need to be keenly aware that eventually investors need liquidity, and you have an ethical and legal obligation do what is best for your investors. Benjamin Joffe’s article “What Every Founder Should Know About Exits” is an excellent discussion on the topic. In fact, if you don’t think about your exit, you will likely make mistakes that will be more painful and expensive to fix forensically. My point is, we investors want to back missionaries, not mercenaries.
And BTW, hunter green is way nicer than baby blue.
