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Dr. K Mark Weaver, Rohrer Chair of Entrepreneurial
Studies, Dr. Pat Dickson, Associate Professor of Strategic
Management, Key words: venture finance, exit strategies, comparative financing, research methods
The primary research issue in this project is the determination of how equity based investors view the importance of exit strategies and to develop an exit readiness index to measure firms readiness and equity investors sense of importance of each of the criteria for funding. Few private equity funded firms will ever achieve an IPO. Most firms are subject to a trade sale but few have a proactive exit strategy that considers anything other than the IPO in the sky model. This research project considers the following research propositions: 'Firms seeking private equity funding that create a proactive and viable exit strategy will improve their chances of raising equity finance. (Tested initially by review of the importance of exit strategies to venture capital sources) Firms seeking private equity funding that create a proactive and viable exit strategy will improve their chances of achieving a successful exit. Therefore: (1) Can we develop an exit strategy guide for entrepreneurs seeking private equity?, and (2) What information can be provided to policy makers that impacts job creation and investment productivity?. This paper will show the initial results including interviews with Angels and Venture Capital fund managers, entrepreneurs, and examinations of web site investment criteria. Preliminary data from Australia and the United States will be examined in this paper. The project will present a model to expand the research and to involve researchers in several countries. The paper will include an “Exit Ready Index (ERI)” based on interviews with investors. Longer term, the study will consider data across a number of technology sectors to determine criteria for the ERI on a sector basis. The ERI will then be validated and applied to a longitudinal study of start-up and nascent firms to determine predictive ability. The raising and harvesting of equity investments in new and growing firms is a topic that is of interest to all parties in the investing equation-entrepreneurs, formal investors, angels and economic development entities. This research proposes the development and testing of an “Exit Ready Index”. This index could be used to assist in the search for equity and the screening of investment alternatives. The primary research issue in this project is to determine the influence of the existence of exit strategies on the ability of firms to raise equity capital. Gladstone and Gladstone (2002) clearly state that how the venture capitalist will exit the investments will be a critical factor influencing investment decisions. The reality of venture capital finance is that very few private equity funded firms will ever achieve an IPO. Gompers and Lerner (2001) suggest that in the United States and United Kingdom, the historical exit strategy has been by selling firms to a corporate acquirer-a trade sale. The angels and venture capitalists contacted in the project development phase acknowledged that they spent a majority of their time creating trade sale opportunities and that very few firms had a proactive exit strategy. This result and the experiences of the research team in successful exits has led to this research on whether a proactive exit strategy can increase the chances of obtaining angel and venture capital financing and of achieving successful exits for either party. Hall and Hofer (1993) in an earlier work examined forty-three investment criteria and the identification of exit mechanisms was rated 4.16/5.00 in importance, clearly showing that planned exits are important. Based on the experience of the research team and the basic citations, this research project considers the following research propositions: 1. 'Firms seeking private equity funding that create a proactive and viable exit strategy will improve their chances of raising equity finance. 2. Firms seeking private equity funding that create a proactive and viable exit strategy will improve their chances of achieving a successful exit.’ Answering these two initial propositions should significantly help answer two related questions arising from this proposition: (1) Can we develop an exit strategy guide for entrepreneurs seeking private equity? and (2) What information can be provided to policy makers that impacts job creation and investment productivity? The development of an Exit Ready Index (ERI) is included to prompt discussion and solicit input on potential additions and approaches to answer the research questions. The project will present a model to expand the research and to involve researchers in several countries. The paper will include the draft of the preliminary ‘Exit Ready Index (ERI)’ based on the initial qualitative reviews of successful exits and interviews with investors. While it is true that many other factors such as building a good team, creating a good product and having a competitive advantage are all necessary, the private equity investor is really focused on the exit. Without the exit possibility, they find it hard to commit funds. Since IPOs are very rare, having alternative strategies such as trade sales increases the confidence of the investors. Thus a strong, viable exit strategy should have the effect of improving the funding commitment. This research is core to the entrepreneurial process and to commercialisation of innovation. It has the potential to significantly impact the way in which entrepreneurs build ventures and in providing better guidelines to investors. It also has implications for government policy in job creation and funding allocation.
Making a strategic exit, as a proactive part of the investment process more effective, is projected to have the following effects: It will create realistic expectation on the part of the entrepreneur
These impacts are expected to: This rather ambitious view of the potential impacts is the reason for examining exit strategies and developing an international research project that examines multiple countries. Limited venture and equity capital in markets could be increased with the development of exit strategies in business plans and investment proposals.
In order to answer the core questions posed in the paper we use the initial results of interviews with angels and venture capital fund managers and the examinations of web site investment criteria about the use or non use of exit strategies, equity source specifications on use of exits. Comparisons of a sample of United States equity sources and Australian equity firm practices are discussed. The initial interview with over 30 people clearly indicated the need for and exit model. With any research idea, it is imperative to establish the prior research in the target domain. To do this the research team conducted a literature review (which is still on-going), and contacted senior researchers in entrepreneurship. Although there is still further work to be done in this area, the initial conclusions are that the area has little prior research and that this research study is unique and important. Prior articles were uncovered from trade journals providing advice on how trade firms could sell their business. These were often simple checklists or subtle advertisements from business brokers. Only two studies of any serious academic content were noted, one from Singapore and one Germany. Both these studies were case studies of several firms that had achieved an IPO. In addition to the knowledge of the research team, who had seen no evidence of any research results in this area, Dr. McKaskill contacted three eminent scholars in entrepreneurship and requested from them any references they could provide on ‘exit strategies of private equity funded firms’. The results of these enquiries indicated that little had been done and that no substantive research results were know to the scholars. Excerpts from the responses are shown below: “I agree with you that little research has been done
on the exist strategy. Most of the work that I have seen talks
about IPO. Other work covers exit strategies by well-established
companies. Given that IPOs are ONLY one option, there is a
need to understand why entrepreneurs may or may not use this
approach. Also, predicting the choice of exit strategies would
be an important research issue. There is little, if any, empirical
guidance in this regard. I know this because I am preparing
for a seminar and have done a thorough review Shaker A. Zahra “ There is nothing specifically on "exit readiness" - that's an interesting issue to explore. Indeed, the whole issue of the exit process (for angels, VCs and entrepreneurs) has received very little attention from researchers.” (e-mail 8/10/2002) Professor Colin Mason
Ben Oviatt, Ph.D., Director
From my experiences I have formed a checklist which I now need to develop into an index. From a research methodology point of view, I also need to validate this list with experienced executives in the VC industry like yourself. I would like your help to: Ensure that each question is meaningful and will not be misinterpreted,
thus any rewording or clarification will help. These interviews and consultations have led the research
team to suggest the following methods for developing the Exit
Ready Index. This part of the study quizzed Angels, Venture Capital Firms, Mentors, successful entrepreneurs and incubator managers to ascertain their opinions on what it takes to be ‘exit ready’. The list of characteristics or indicators was then refined and a consensus list produced. The refined list was developed first to examine trade sale readiness as an exit option. The pilot questionnaire has been developed to permit firms to report their progress in getting exit ready. (see Appendix 1) Based on this pilot questionnaire, actual firms can be surveyed and their progress reported to develop their Weighted Index of Exit Readiness. The final index could then be then be applied by selected venture capitalists will also be asked to apply the Index to both successful exits and failures to show that it reasonably discriminates between successful and failed exits. The web site reviews were conducted for 42 Australian equity investment firms listed in the Australian Venture Capital Guide 2002 and 61 United States firms primarily from a North Eastern region entrepreneurial forum. Web sites were examined for mention of the need for exit discussions for funding. The basic demographics were also collected on year founded, current number of portfolio companies, investment preferences, and number of professional staff. Each firm was then evaluated on a scale of 1(no mention) to 5 (Essential) based on how critical and how much emphasis was place on the need for exits in funding requests. Scoring was done by at least two people based on the same web reviews and any differences were noted and reconsidered to reach agreement. The table below lists how sites were evaluated and scoring applied.
Phase 2 of the reviews involved summaries of the key descriptive variables about the equity investors. The tables below show the comparison of the Australian (AVC) firms and the United States (USVC) firms.
Table 1 shows that the majority of the firms in both samples were founded since 1997 and indicates the lure of the entrepreneurial ventures for private investment funds. However, since 2000 and the USA dot.com bubble, only one new equity investment firm has been started in Australia and none in the survey of firms in the North Eastern US.
Table 2 shows the investment levels of the firms in the two countries. The amounts have all been converted to US dollars for ease of discussion. In the AVC sample and the USVC sample the percentage of firms that invest under $5 million and those over $5 million are about equally split. The ranges are from a minimum of $300,000 to $500,000 for the samples and maximums of nearly $60 million to $75 million in the larger firms. One interesting fact is that in US Dollars, the two samples are remarkably similar. There are a slightly higher percentage of early or seed funds in the USVC sample and this may be an area where other countries see difficulty. The use of the exit readiness index would be especially interesting to forming more early stage or smaller investment firms because of the increased efficiency this might introduce.
Table 3 reports the capital under management of the equity investment firms. It shows that the range and size of firm investment portfolios are much larger in the USVC sample. While only 5 AVC firms were over $200 million and non over $326 million, 17 USVC firms had over $200 million and the largest reported firm, APAX Partners, in King of Prussia Pennsylvania reported over $ 11 billion under management. This finding shows that the US venture industry is better developed, has a larger base and is capable of very large investments. The need for exits other than IPOs may be increasing with the decline of market opportunities for even large firms in the current market malaise. Considerable national resources are spent at all levels of Government and through our educational institutions on encouraging, developing and commercialising inventions. The objective is to capitalise on our knowledge, create jobs, generate exports, encourage foreign direct investment and build sustainable industries or sectors. We see the private equity investment sector, angel and venture capital firms, as providing risk money to move inventions from early stage prototypes to commercial reality. This research project is designed to show that the development of an exit readiness index, initially focusing on trade sale exits, will show that firms are ‘Exit Ready’ and they will have a higher probability of raising private equity finance and have a higher probability of achieving a successful exit. The index from the research shows firms what needs to be done to build viable exit strategies that result in private equity finance and successful exits. This should in turn increase returns to angels and venture capital firms, stimulating the flow of funds into that sector. Successful entrepreneurs are also expected to create new ventures and put sales proceeds back to work in the sector. Additional benefits will more informed inventors and entrepreneurs, a more knowledgeable private equity market, better allocation of Government funding, and a shorter time to commercialisation. Testing of the Exit Ready Index is the next phase of the research and interested parties are encouraged to contact the authors to participate in your region or country. This research clearly shows that insufficient attention has been spent on identifying exit criteria, evaluating investments with exit in mind and in informing firms what needs to be done to access the limited equity funds available to firms. The addition of additional items on the proposed index will be carefully evaluated to keep the instrument short so that firms will be more likely to respond to requests for information. No one index or paper can address all of the concerns and one limit to this research is the limited web searches in two countries. Additional countries and more searches in the pilot countries will be conducted once funding is available. A second possible limitation is the focus on trade sales, but since they are the majority of reported exits, this is a way to focus the effort. Modifications of the instrument for other exits are possible and will depend on access and funding issues. If firms were to develop “exit portfolios” consisting of the items that are important to equity investors and government promotion organizations, they could have a competitive advantage over those firms that still think the idea is enough.
Gladstone, David and Gladstone, Laura (2002), Venture Capital Handbook-An Entrepreneurs Guide to Raising Venture Capital, Financial Times-Prentice Hall, p 85. Gompers, Paul A. and Lerner, Josh, (2001) The Money of Invention-How Venture Capital Creates Wealth, Harvard Business School Press, Boston. P 219 Hall, J. and Hofer, C.W., “Venture Capitalists Decision Criteria in New Venture Evaluation”, Journal of Business Venturing, 1993, p. 46.
Appendix 1: Sample Survey of Exit Readiness Survey of Exit Readiness of Private Companies Please complete this survey if you are a major decision maker in a private firm (e.g. CEO, CFO, significant shareholder, Board Director). I. Company Profile: 1. a. Year Founded:________ b. Number of employees:_______ 2. Do a small number of shareholders between them hold 51% of the equity: __YES ___NO 3. Do you have independent external private equity investment: _____YES_____NO If YES: a. Angel Investment _____YES _____NO b. Venture Capital investment _____YES _____NO 4. Will you be seeking to raise equity finance in the 2003/2004 ___ YES ___NO 5. Sector in which your firm operates: (e.g Biotechnology):______________________ 6. Is this a family owned firm (family members hold a controlling interest)___ YES ___NO
II. Exit Plan for Independent Private Investors or major shareholders 1. What is your current anticipated exit path? Please check one only. a. ( ) No exit strategy at this time b. ( ) Pass control to other family members c. ( ) Leveraged buyout by managers or employees d. ( ) Close down the operation and end all operations e. ( ) Trade sale (sell 100% to another company) f. ( ) IPO (Initial Public Offering)
Name: _____________________ Phone: ____________ e-mail:______________ Company Name: __________________________________________
Return to: Professor Tom McKaskill Phone: +61 (3) 9214 8422
III. Trade Sale Exit Planning - Agreement Items – Please indicate your level of agreement with each of the following statements: Strongly Disagree (SD), Disagree (D), Neutral (N), Agree (A), Strongly Agree (SA)
B. Attainment Items – If ‘Trade Sale’ is your anticipated or back-up exit path, please indicate for each of the items listed below, your current level of achievement/progress/attainment. For each item below indicate to what extent you have made progress on achieving the stated condition. No Progress (NP), Little Progress (LP), Reasonable Progress (RP), Significant Progress (SP), Fully Accomplished (FA), Not Apply (NA)
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© Tom McKaskill 2007
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