Monday June 8, 2015 0 comments
By Peter Adams
Rockies Venture Club
There are two customers every venture-backed company must understand and build a value proposition for – and those value propositions are often totally different, yet totally interdependent.
The first customer is the person or company who buys your product. You must understand their needs, the competition, the size of the problem, the best channel to reach them and many more questions in order to be successful. But this is only half of the customer value proposition.
The second customer is the company who buys your business. You must also understand their needs, the competition, the size of the problem and the best channel to reach them and many more questions to be successful. In many cases, this buyer will pay more than the total of all purchases from the first customer. Understanding this second customer and their needs is another way of saying that the company has an exit strategy that goes beyond the obvious that an IPO or acquisition are the goal.
A real exit strategy doesn’t just identify that an acquisition may occur, but it takes many factors into account including the strategic value of the company to larger companies in the industry or in adjacent industries. It asks about where those companies are going and what is missing from their strategy that our company can provide? An exit strategy asks what the size of typical acquisitions may be in the industry so that the company’s development strategy aligns with where the industry typically engages in acquisition. For example, a cardiac device company would look for an exit at $250 million and up for an FDA-approved device, whereas a food and beverage brand might go for $20-30 million. An exit strategy would have an analysis of the multiples for acquisitions in the industry, including an analysis regarding the disparities between the multiples which can be significant.
Understanding the second customer from the beginning can offer the company many opportunities to build something of value for them from the start. If you follow the guidelines from The Seven Habits of Highly Successful People, you know that Habit #2 is “Begin with the end in mind.” If you have a specific target in mind, then you could do many things from the start that would make integration into their systems easier. For example, you could build your software using the same stack as the acquiring company. You could meet with the company leadership and come to understand what they’re lacking. You could develop relationships with the leadership of multiple potential acquirers, thus increasing your odds of being approached for acquisition when the right time comes for their company.
A well-crafted exit strategy allows the CEO to demonstrate their knowledge of their industry, the major players and the trends showing where the industry is going. They will be looking at where the proverbial puck is going and not where it has been. Asking this question demonstrates that the investor is astute and is gauging how deep the CEO's knowledge of the industry goes.
Perhaps most importantly, the exit strategy question shows the CEO’s mindset. I often get the answer that “we’re just building a great company here and we don’t want to exit.” That’s great, but what it tells the investor is that the founders and investors’ interests are not aligned. The founders will profit from day to day operations of the company, but investors only profit from the exit. When founders won’t exit, the result is rarely good for the investors.
Startups who understand their two customers are more likely to succeed and certainly more likely to be attractive to smart venture capital and angel investors. Don’t think of the exit strategy as just a liquidity event – think of it as a way of understanding your second customer.