Diligence Series: Exploring Exits

AUTHOR: Patrick Zailckas

For better or for worse, contemplating exit opportunities starts to widen one’s eyes. Big ticket hallmark exits making front pages of media publications are part of the foundational allure that made the venture capital industry what it is today. This post of the Diligence Series takes a look at evaluating exit opportunities from a more grounded perspective. Let’s dive in.‍

Exit & Investment Landscapes: An Overview

When considering the exit potential of an investment, we must begin by mapping and understanding the recent and applicable exit transaction landscape in the focus market. The goal of this investigation is to determine what reasonable exit pathways exist for the target company, focusing on possible buyers and noticeable M&A or investment trends in the market. These transactions can also help us to gauge whether the proposed deal is underpriced, fairly priced, or overpriced – valuation analyses, which are out of scope of this article, often complement exit analyses. Ultimately, these analyses should seek to tell the investor whether a reasonable opportunity exists for a liquidity event to generate returns on their investment, and whether the price offered to the investor is enticing.‍

Core Questions To Explore An Exit Opportunity

• What recent transactions (M&A, Significant Investments) have taken place across the focus market?
• What themes emerge from the transaction landscape? (e.g., consolidation, M&A appetite, saturation)
• Do any potential future acquirers stand out based upon witnessed transactions?‍

‍Information Gathering

Exit and investment landscape transactions represent objective data points which are often readily discoverable through online independent research. Not all transaction details are publicly circulated and may require a subscription with a private investment database. Company provided materials and management interviews may be helpful sources of information to detail sample transactions, although bias may exist in the presentation of certain transactions and the omission of others. As such, it is strongly recommended to always conduct independent online research to identify relevant transaction occurrences, even if specifics of these deals are not publicized. Sample research outlets might include:

• Pitchbook
• Crunchbase
• TechCrunch / Forbes / other financial media outlets
• General online research (e.g. Google & News tabs)‍

Independent research should focus on confirming:

• Transaction participants
• Transaction type (e.g., M&A versus major investment – if an investment note which round)
• Transaction amount ($)
• Transaction date
• Transaction pricing (e.g., valuation multiple on revenue or EBITDA)
• Transaction key context (e.g., the underlying purpose or theme behind the transaction, if available)‍

In the absence of a private investment database subscription, public media publishings often provide excellent theme-oriented context surrounding a noteworthy transaction. For example, a major investment by Airbnb into a start-up’s Series B round or an acquisition altogether may offer a glimpse into a market giant’s strategic interests around “owning” or “monetizing” a particular niche of the focus market. Articles written about the transaction may introduce other “related recent transactions” which foster a pseudo chain-discovery result for the researcher. This can 1) broaden one’s perception of the relevant activity happening in the space, and 2) often yield links to additional articles detailing those related transactions. Assembling a robust list of transactions and their interrelatedness is a key first step to defining themes around the witnessed activity of a company’s exit and investment landscape.‍

Occasionally company-provided investor decks may include a page outlining sample M&A transactions and/or noteworthy investments relevant to the company’s target industry or pursuit. The purpose of this content is to offer the investor audience a glimpse into the leadership’s ideas on executing on some future liquidity event to generate investor returns. Demonstrating that one’s business operates in a space with healthy M&A activity and/or noteworthy institutional investments can lend confidence to prospective investors that strong execution upon a worthwhile business model can ultimately lead toward a return-generating transaction. This information should be verified using third party sources, as it is often exclusionary of recent purchases that don’t paint the exit landscape in the best of lights.

‍

‍Mapping The Landscape

The epicenter of a robust exit & investment landscape analysis is to map and draw valuable insights from recent and relevant exits and/or investments in the company’s focus market. The goal of this investigation is to determine what reasonable exit pathways may exist for the target company, focusing on possible buyers and noticeable M&A trends in the market. A well-prepared exit & investment landscape assessment should tell the investor audience whether a reasonable opportunity exists for an eventual liquidity event to occur such that the investor may generate returns on an investment.

‍Given the high degree of liquidity risk inherent in venture-stage investments, it is critical for investors to identify, explore, and deeply understand prospective pathways for the target company to achieve some liquidity event in the future. It is often most helpful to arrange your research findings in a thoughtfully-organized tabular asset. You’ll want to label each transaction according to the following markers:

• Investment Lead: buyer is recognized as the lead investor on the designated funding round, which can suggest stronger committed interest in the seller, perhaps even hinting at a potential future acquisition
• Investment Participant: buyer is recognized as an investor in the designated funding round. The size of the investment can hint at the “strength” of commitment interest in the seller
• M&A: M&A purchase of seller by buyer suggests strong interest to capture market value from the seller’s operating market. Strings of M&A purchases by similar market operators can emphasize buyer strategic interest to “own” or “dominate” a particular market
• Internal Project: signifies an internal company project launch that may be branded under another name. An internal endeavor shows organic interest by the buyer to build a presence within a particular market niche‍

Mapping Step 1: Examine Market Operator Investment And M&A Activity

Market operators represent companies who have a prominent foothold within the target market of the target investment company. Typically these operators are easy to identify as young or old “movers and shakers” for the market, and have demonstrated sufficient M&A or major investment activity to provide a decent sample size of exit transactions. Each market is unique and must be segmented as such.‍

As an example, the hospitality market can possibly be broken into a handful of different “types” of operators such as “tech-enabled, newcomers” vs. “tech-enabled, established” vs. “traditional operator” to encompass an exploration of how potential acquirers across the hospitality industry have transacted recently. Across these transactions, common themes can emerge which can either sweeten or threaten the target investment opportunity’s exit prospects to the operators listed or similar unlisted operators.‍

Be sure to note whether the transaction type is differentiated among investment lead, investment participant, M&A, or internal project as detailed above. Organize these findings in a tabular fashion to help make sense of what’s happening.‍

Mapping Step 2: Examine Prominent Industry Investor Activity

Investor activity primarily seeks to explore noteworthy investor backing of market competitors to the target investment company. Significant investments by 1) major VC firms, 2) industry giants, and/or 3) major PE firms or banks can clarify the degree of strategic industry or VC interest in alternate competitors and the market niche in general. These investors may be easy to identify for the market, though many VC firms or banks are industry agnostic. “Influence” is the key theme to keep in mind. Positively, “influential capital” invested in market competitors can indicate market validation through bets made by reputable firms. Negatively, major investments into market competitors can also suggest crowded interests, which may make future funding or exit opportunities more difficult to come by if the target company is outpaced by competing ventures.‍

Be sure to note whether the transaction type is differentiated as investment lead or investment participant as detailed above. Organize these findings in a tabular fashion to help make sense of what’s happening to the reader.‍

We hope you’ve enjoyed this installment of the Diligence Series. If you are a private investor you may find the topics discussed helpful in framing the next investment opportunities you come across. If you are a founder reading along, this may give you further insight into what investors may be considering the next time you go out to raise capital. Until next time!‍