The stewardess on my red-eye to Argentina was delivering a familiar speech as we got ready for takeoff.
Her voice washed over me as I curled up in a window seat, reading the business plan for a tech startup.
“There are ten emergency exits on this Boeing 777 aircraft,” I heard her say. “Four in the front, four in the back, and two located over the wings.”
The business plan I was looking at was intriguing. Strong team, interesting product, initial traction. But something about it was bothering me, nagging at me.
The stewardess continued her speech. “Keep in mind that your nearest exit may be behind you.”
When she finished her presentation, I glanced around to locate the emergency exits. And as I buckled my seatbelt, I realized what had been bothering me:
The plane had ten emergency exits. The flight crew knew exactly where they were, and how and when to use them. They had a rock-solid exit strategy.
But the startup I’d been reading about didn’t have any “exit strategy” at all.
In other words, it didn’t have a way for me to “exit” my investment and make a big profit!
Exit Strategy
Investing in early-stage companies can be fun and exciting. It’s always a thrill to see a dream become a reality.
But to make money, you need “an exit.”
Essentially, you enter an investment by writing a check. And you exit by getting your money back — or hopefully, getting back many times your money. (We target a 10x return on all of our startup investments.)
That’s why, if you’re exploring making an early-stage investment, one of the most important questions you have to ask is this:
“What’s the exit strategy?”
Three Ways to Mint Money from Startup Investing
Airplanes have multiple exit possibilities — two over here, two over there, two in the back. They’re everywhere.
It’s the same thing with startups. Here are the three main ways a company can exit:
1) The startup is acquired by a bigger company.
2) The startup goes public in an initial public offering (an IPO).
3) The startup becomes profitable, and determines it doesn’t need all its cash for growth. At that point, it can return money to shareholders in the form of dividends and distributions.
The Odds
If you’re playing by the odds, it’s unlikely you’ll be rewarded through dividends or an IPO. Very few startups end up paying a dividend. And only a tiny fraction of them achieve enough scale or stability to go public.
Your #1 exit strategy? An acquisition.
Looking For Clues
Unlike on planes, exits for startups aren’t always clearly marked.
But the clues are often there.
The clues include a big market. Or a sector that’s growing like a weed. Or one or more acquirers that can write a big check.
Here’s an example you might be familiar with:
By 2012, Facebook had nearly one billion users. Many of those users spent hours each day on Facebook’s website.
Meanwhile, two major trends were picking up steam. First, consumers were spending far more time on their mobile devices. And second, consumers had fallen in love with taking pictures on their phones and uploading them to sites like Facebook.
So in April 2012, Facebook acquired a young private startup — a photo app called Instagram — for $1 billion.
What did Instagram have that was possibly worth $1 billion?
Well, first of all, it was targeting a huge market: casual photographers. Secondly, it was on the cutting edge of several emerging sectors, including Mobile. And thirdly, several potential acquirers — including Facebook, Twitter, and Yahoo — were eager, even desperate, to grow their mobile efforts, and could afford to write huge checks.
Why I “Passed”
In contrast to Instagram, the business I was reviewing on the plane lacked any signs of a future potential exit.
It was targeting a small, niche audience. Forget about reaching a billion users. It would have trouble scaling to 10,000 users.
It wasn’t part of a fast-growing sector like Mobile.
And it was nearly impossible to imagine a bigger company buying it. There wouldn’t be much to buy — no big audience, for example, and no proprietary technology.
It had no exit strategy.
So for me, it was a clear “pass.”
Always Be Exiting
Investing in a startup where you can’t identify an exit strategy is like getting on a plane that doesn’t have the exits clearly mapped.
So when it comes to startup investing, make sure you ask yourself, “What’s the exit strategy?”
Happy Investing.
Best Regards,
Founder
Crowdability.com
