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Analysis of Exit Alternatives

Updated: Apr 10, 2023

(Newsletter: tsCFO.005 v2 2023.04.09)





















Exit Strategy - Introduction


Tech startups aiming for a big exit win should begin with the end in mind. Founders must build their tech startup through a combination of innovative thinking and hard work, groom early relationships with potential investors, be proactive in exit preparation, and effectively manage the exit process. It is also helpful to position the tech startup in the right place at the right time (read: be lucky, though part of “being lucky” is taking a strategic compass bearing at inception, and heading off in a promising “product-market fit” direction, with course corrections along the way).


I am familiar with a cash strapped tech startup that managed a $70M M&A (Merger & Acquisition) exit. Based on some coffee chat, I believe there may have been a thin line between that transaction and an impending fire sale. The sun shone in the form of perfect timing, and luck in finding a motivated strategic purchaser with an influential champion who believed in the technology. While the exit was a big win for the local founders, the acquisition did not result in commercial success for the sophisticated NASDAQ purchaser. It isn’t always easy to predict the future.


When raising a financing, timing is important. You shouldn’t start preparing your soil in mid-summer just because you suddenly feel inspired by the impending harvest in plain sight. Equity markets move in cycles. Winter is coming. Better to time your activity to survive until the spring planting season, which might mean getting lean for a while. The best time to launch a tech startup is when you have enough lead time to develop a minimum viable commercial product / service, and generate revenue from motivated early customers, at which point you are ready to pitch to investors beyond “friends & family”. This might mean launching your startup in the fall or winter, so you are well timed for investors by the spring planting season. Like grumpy bears, Angel and VC investors prefer to hibernate through an equity winter. The best tech startup opportunities can shake a grumpy investor out of hibernation, but only at a low-ball valuation.


Seeking an exit means the Founders have emotionally accepted the idea of walking away from their tech startup “baby”. An exit means a loss of control, and a resulting lifestyle change for the Founders who now have to answer to head-office. In the post-exit organization, the Acquiror (Purchaser) typically requires the Founders to remain involved for a period of 1-3 years. In practice, Founders with sufficient financial security often chose to move on once they have satisfied the minimum employment period required by the deal terms. Founders should think through what life will look like on the other side of a successful exit, and plan accordingly.


Technical, sales and marketing employees tend to be highly valued and financially encouraged to stick around in the post-exit organization. In sharp contrast, the CFO is generally shown the door shortly after they work enough late nights to close the M&A deal. Who ever said life was fair? Tech startup CFO’s should negotiate accelerated option vesting before any change in control to avoid getting left behind. The tech startup CFO role normally gets diminished when the post-exit organization transitions the financial and accounting systems to their head office, leaving a significantly reduced financial role at the tech startup location.


Being prepared in advance for a financing transaction allows the Founders to move quickly in a hot technology space that is suddenly being consolidated by large players. You don’t want to be the last company standing when the music stops. Being prepared means managing your secure server Data Room, which must have fully executed (all signatures in place) versions of all documents an investor might ask for as they go through their due diligence process. Data Room documentation covers every aspect of the business, and is discussed in more detail in my future Newsletter tsCFO.008 on Valuation. Highlights of Data Room contents include Legal (IP, corporate documents), Financial (financial statements, forecast model), Operational R&D (product roadmap, technology description), Operational S&M (customer profiles, channel partners, pricing, go-to-market strategy, competition), Operational Admin (business plan, pitch deck, SWOT assessment, strategy, culture, employee agreements, option compensation, supplier contracts), and Tax (payroll compliance, tax returns and notices of assessment, a strategy for any US sales tax exposure). The existence of a subsidiary can replicate portions of this list, depending on materiality. To package it all up for an exit pitch, a tech startup can put together a CIM (Confidential Information Memorandum) that is effectively an M&A deal “sales brochure” with 20 slides, maximum 12 lines per topic, rich in graphics. Coordinating the population of the Data Room with quality documents requires a significant effort from a senior resource like a Fractional CFO, or an M&A Advisor.


One more thought on the Data Room. You must be careful not to disclose too much detail too early in the process. Be wary of “verbal” commitments from potential investors, even from people recommended by your trusted advisors. Organize different “Data Rooms” with different levels of information (summary level, generic detail, full detail), and control “read only” access with time limited deadlines. Don’t share the most sensitive information until you are confident the deal is happening – which generally means the legal teams on both sides are fussing with detailed clauses in a draft formal agreement. Some “potential investors” can be VC (Venture Capital) information junkies, or worse yet, unethical spies seeking information that will be used against your tech startup when they invest in your competitor. The most confidential information to protect, until the Purchaser is very committed to the deal, includes product roadmap details (revealing your technology strategy), employee team details (vs. employee A,B,C), key customer names (vs. customer A,B,C), trade secrets (internal magic which can’t be found in patent documentation), and any secret bridge financing plans you have if cash is tight and the deal takes longer to close than expected (unethical Purchasers may delay the deal if a tech startup is nearly out of cash, and try to force through a new set of harsher investment terms).


Proactive exit strategies involve grooming relationships with a few potential strategic Acquirors (Purchasers) who can leverage your technology into significant revenue growth and profitability. The CEO (often in collaboration with an M&A Advisor) should first identify potential investor candidates by thinking strategically about the profile of a potential purchaser, and searching for organizations with that profile (Google is your friend, think globally). The CEO should then pursue an early connection (be persistent), and build trust through brief status updates over time. Keeping a few of these potential purchaser relationships warm is especially valuable if the CEO suddenly gets an unsolicited M&A offer, which can be leveraged quickly into a competitive bid situation if the tech startup is sufficiently prepared. The strongest exit valuations generally happen in a competitive bid situation.


Investment Banking firms come in a range of sizes and specialties, including some that cater specifically to tech startups. Investment Bankers can facilitate an exit transaction through either the common M&A (Merger & Acquisition) path, or the less travelled IPO (Initial Public Offering) / Reverse Takeover (RTO) path to a public stock exchange.


Investment Banking firms involved in a tech startup will generally provide Advisory services for a fixed fee (roughly $30-$60k spread over milestones), and a success fee percentage (~8% for smaller deals, ~5% for larger deals) of the exit valuation. Mid-market Investment Banking firms (eg. Garibaldi Capital Advisors) specialize in M&A deals for tech startups approaching $5M revenue, where there is investor interest from both strategic investors (often NASDAQ listed tech companies), and Private Equity firms (seeking predictable cashflow deals). A few boutique Investment Banking firms (eg. Strategic Exits Partners) specialize in early M&A exits for tech startups with modest revenue. Other Investment Banking firms specialize in public stock exchange listings.


It is normally a good idea to get Investment Bankers involved in an M&A exit transaction, unless the tech startup has a Board member with sufficient M&A experience and bandwidth to lead the charge. An exit is a complex process that must be managed carefully. The CEO already has a full-time job, so they probably don’t have the cycles to take it on. The CEO can’t ignore operations because a key part of closing a successful exit is ensuring revenue and profit growth continue to meet or exceed forecast targets. In the final stages of an exit deal, the CEO comes under increasing pressure from all sides, especially legal teams that are hashing out deal terms. Legal details can’t be ignored - they have teeth, and the devil lurks among them. Early in the exit process, an M&A Advisor can take the lead by developing the funnel, filtering through prospective Purchasers and engaging with the selected few. Having this M&A Advisor support allows the CEO to stay focused on operations. Later in the exit process, the CEO will be forced to shift focus away from operations to close the deal and negotiate final terms.


Having covered general exit strategy above, we can now dive into the benefits and weaknesses of specific exit situations (Exit1 to Exit5).



Exit1 - Early M&A by Strategic Purchaser


There are often two valuation peaks during the life of a tech startup. The first peak occurs after the technology is proven and a commercial product-market fit is demonstrated with early customers. Testimonials from early adopters point to a bright future. The tech startup might even be approaching positive cashflow. Distant bumps and potholes down the road to scaled up commercialization are out of sight, and out of mind. The world is full of rainbows. The positive energy of the moment represents an early exit opportunity for founders who have been disciplined enough to restrict early financings to vanilla common shares, or at least have been careful not to assign a “change in control” veto to any investor (such as a Series A preferred shareholder). There can be significant advantages to an early exit, but the exit valuation will rate as a baseball single or double, and not a grand slam home run. Logically enough, swinging for a home run valuation typically involves a lot more work, including a long and difficult journey converting the tech startup’s potential into reality by demonstrating revenue growth and profitability in a mainstream market (discussed under the next “Exit2” heading below).


To take advantage of the first valuation peak involving an early M&A exit, a tech startup needs to be proactive in seeking strategic investors (Purchasers), most likely with the help of an M&A Advisor. In the early years of a tech startup’s corporate development there has not been much time to attract the kind of attention that triggers unsolicited M&A offers from strategic investors. This means the tech startup probably has to seek out the Purchaser. After helping to develop a funnel of potential Purchasers, an M&A Advisor can help filter the list down to a small number for early exit negotiations. The valuation range for an early exit can be quite wide. Many M&A exits are done under $10M, and some are even under $1M.


A strategic investor is typically a large technology company (think NASDAQ) that struggles to foster real innovation within their corporate culture. As established products mature through their product life cycles and begin to age out, large corporations seek ongoing revenue growth by acquiring complimentary tech startups which allow them to leverage their established sales and marketing strengths to either expand existing products / services, or penetrate new markets.


To paint a very rough picture, here are some guidelines on timing. Any early tech startup exit takes at least 6-18 months to complete. Data Room preparation can take 1-5 months, involving documents investors require for their due diligence process. Consider using an M&A Advisor to develop a prospective Acquiror (Purchaser) deal funnel starting with 50-200 companies. Then use a structured process to earn the right to as many 30 minute calls as you can manage with the potential Purchaser’s M&A team. Filter these results down to 25 prospective Purchasers. Aim to start a high-level due diligence process with the top 8. Aim to have 3 prospective purchasers in a competitive bid situation at the end of the process. The M&A deal negotiation takes 2-4 months. The final deal close (involving legal teams, accountants, Board members, shareholder approvals, your management team, your M&A Advisor) can drag on for months, which can be helpful if you need time to bring a competitive bid to the table. Be careful not to sign-away the tech startup’s right to solicit competitive bids in any commitment you make to a potential Purchaser. On the other hand, if Founders love the deal you’ve already got, push to get it closed before something beyond anyone’s control puts it at risk.


Don’t burn any bridges - smoldering embers can quickly burst back into flame under the right conditions. Purchasers can flip between a “make internally”, or “buy from outside” decision, depending on their internal politics. The CEO has to play the “good cop” role, maintaining relationships with potential Purchasers. The Purchaser will likely try to hide details of the tech startup’s strategic value to their business model to avoid weakening their negotiating position. The tech startup will want to investigate any valuation metric used by the Purchaser, if one can be identified. It is up to the tech startup (or their M&A Advisor) to pierce through the fog and highlight tech startup’s value-add as a key negotiating tactic. A good M&A Advisor will play a “bad cop” role with the potential Purchaser, which is a healthy part of negotiating for an optimal valuation. The “good cop” CEO can’t let an overly aggressive M&A Advisor poison the relationship with potential Purchasers. As the deal approaches the point of closing, with legal details being finalized, the CEO’s involvement in the deal becomes more prominent. A competent lawyer working for the tech startup must be on the alert for aggressive attempts by the Purchaser’s legal team to slip nasty legal clauses into the agreement that go beyond the scope of the signed Term Sheet, and sometimes even directly violate the intent of the Term Sheet.


If a tech startup is engaged in M&A discussions, the employees generally know about it long before any formal announcement from the CEO. It is best to get ahead of the internal communication issue, because in the absence of better information, employees will assume the worst. While it is important to manage employee expectations with early disclosure, the discussion should kept to a high level. Nobody knows the outcome of an M&A negotiation in advance, so the M&A deal should be positioned as an experiment conducted on behalf of all shareholders, who legitimately seek a return on their investment through an exit. Note that the deal under negotiation could easily derail during a long and complex M&A exit process. Like dating, failure to establish a long term relationship doesn’t mean either party is “bad”, it just means it wasn’t the right fit. There is no taint if a tech startup abandons an M&A negotiation process, other than sorting out a possible settlement with any Investment Banker / M&A Advisor if the exit deal would likely have closed and triggered a success fee in the absence of a Founder decision to kill the deal. Employees should take some comfort in the fact that the deal is unlikely to proceed unless the Purchaser values both management and the employee team, since much of the IP value in a tech startup walks out the door after 5pm.


In earlier times, it was not possible to leverage open source code to rapidly develop a scalable web based SaaS software service. The latest AI (Artificial Intelligence) software developments such as ChatGPT are accelerating what can be done quickly with few resources. The hardware side is more constrained in its ability to scale rapidly, but Moore’s Law continues to drive costs down while devices get more powerful, so tech startups with a hardware component are also experiencing rapid innovation. In his classic book “The Lean Startup (2011)”, Eric Ries talks about an accelerated world of Minimum Viable Products (MVP’s), ongoing A/B testing to reveal customer preferences, and a series of rapid pivots in search of a sustainable customer driven business model. This broad trend of rapid tech startup development makes early M&A exits increasingly possible. It is up to tech startup Founders to evaluate the relative risks of different exit strategies, and to determine whether an early exit M&A option (if it exists) is a good fit for their personal goals.


While specific circumstances vary widely between tech startups, a reasonable early exit for Angel investors would be a 3-4x return on their investment within 5 years, on a valuation ranging anywhere from $3M to $30M. There is room for Founders who paid almost nothing for their shares at inception to be amply rewarded within this range, but early exits do not fit into a Venture Capitalist (VC) business model.



Exit2 - Mature M&A by Strategic Purchaser


As Geoffrey Moore described in his classic “Crossing the Chasm (1991)”, there is a difficult bridge building exercise involved in reaching beyond the relatively tolerant 20% “early adopter customers” that are motivated by the latest innovation / technology, and new value created in a specific niche. It is no small thing to build a bridge over the chasm to the distant 80% “mainstream customers” motivated primarily by price, robust commercial grade performance, and convenience. During that bridge building exercise there are many opportunities to slide into the chasm. Well financed competitors can emerge. New substitute technologies can erode your competitive advantage. A tech startup can struggle to get the attention of channel partners (distributors and resellers) who aren’t nearly as motivated as the direct sales team. There can be lots of conventional learning curve challenges in scaling up operations to meet customer demand. However, unless you have chosen the early Exit1 option above, you have committed to the challenge of building your bridge over the chasm to where the vast majority of your future customers live.


Tech startups need significant financing to build a bridge over the chasm, which generally forces them to go beyond Angel financing into VC territory, unless the tech startup has found some internal magic that lets it bootstrap. As soon as the tech startup has taken the first Series A investment, it is locked into swinging for the home run fence. A Venture Capitalist (VC) has no choice - their business model forces them to target 10x returns for their institutional investor fund within 7-10 years, with anticipated winners offsetting the majority of a VC’s losing investment portfolio. Series A preferred shares issued to VC’s come with a “change in control” veto, which enables the VC to veto a lower-risk 3x return which might be attractive to the Founders. Tragically, due to shifting circumstances, the 3x return might be the Founders best chance for a positive exit. Swinging for the fences increases the probability of a home run, but it also increases the probability of a strike-out. The other impact of accepting VC investment can be a gradual shift in shareholder control from Founders to the VC group, if financing rounds accumulate. It is not uncommon for the VC’s to delicately shift a Founder CEO into another role, as they make room for a more experienced CEO. This can be a good thing for all involved, but not always easy on the Founder’s ego.


The VC will have lots of experience with exits, and when the time comes, they won’t be shy about pushing the exit agenda forward at Board meetings. VC exit timing isn’t always consistent with Founder preferences.


While specific circumstances can vary widely between tech startups, a classic VC exit target is a 10x return on their investment within 7-10 years, for exit valuations starting at $250M. The math looks like this: The VC makes a $5M Series A investment in a tech startup with a pre-money valuation of $20M. Post money, the VC holds ($5M/($20M+$5M)=) 20% of the shares. There are no subsequent financing rounds causing further dilution to any shareholder. On a planned exit in 8 years, the VC needs a 10x return, so the exit valuation must be (($5M*10x)/.2=) $250M. It is not too surprising that a founder CEO can find themselves out of their depth when attempting to grow a company into a $250M valuation for the first time (a rare achievement for even the most seasoned tech executives).



Exit3 - Early IPO on Junior Exchange


At one time, getting listed on a junior stock exchange was a popular financing path for tech startups. Vancouver even boasted a boutique legal firm called Catalyst that specialized in the process. Those days faded away after a few bad actors (most notably, Enron and Arthur Anderson) drove a truck through every legal / tax loophole they could find in using off-shore entities to hide Enron’s debt, until a shift in the energy market caused Enron’s financial house of cards to collapse. In the wake of Enron’s multi-billion dollar melt-down, came new Sarbanes Oxley securities regulations for public stock exchanges in the USA, and equivalent securities regulation in Canada. Other lasting impacts included more intense Financial Statement audits, and personal CEO / CFO liability for any flawed public company disclosure. The whole public markets scene became more difficult and expensive (including higher CEO/CFO compensation and higher audit fees). While the heavy impacts landed on senior stock exchanges like NASDAQ and TSX, junior stock exchanges (eg. TSXV – TSX Venture Exchange) experienced their own version of the tougher securities regulations. Junior exchange listed companies could least afford the higher overhead costs associated with new securities regulation, and the net impact was to decimate the number of tech startups heading for an IPO on a junior stock exchange.


Having painted the broader context for why tech startups generally shy away from early IPO’s in comparison to the 1990’s, there is an offsetting argument. TSXV supports a Capital Pool Company (CPC) program (unique to Canada) which enables individuals with public company experience and a bit of seed financing to launch a public company shell (CPC) with no active business. The CPC shell has a time limited mission to seek out a qualifying transaction or “marriage” with a promising private company through a Reverse Takeover (RTO). The end result gives the tech startup an easier (though more expensive, at ~30% dilution) path to a public exchange listing. The listing allows the tech startup to (at least theoretically) raise money and get liquidity for existing shareholders (including founders, once their shares are released from escrow). Tech startups with strong technology are a logical target for CPC shell qualifying transactions, since it gives CPC shell promoters an exciting story they can use to attract investors.


An engineer friend of mine who founded his own tech startup went down the early IPO path on TSXV through a CPC shell at a time when he was unable to raise any further Angel financing in Vancouver, and he was too early for VC consideration. It was his best option at the time, and it might still work out for him, but he has gone through a predictable wall of public market pain with no liquidity yet in sight. Being a public company means you are on the stage with the spotlight shining. That can be lucrative if you are the Beatles – a polished act getting better with maturity, producing a steady stream of “press release hits” to keep shareholders thrilled. Most tech startups listed on TSXV behave normally – they make some progress, encounter unforeseen challenges, stumble forward in fits and starts with minimal cash because almost everything takes longer and costs more than expected (sound familiar?). Even if the trajectory is forward and upwards over time, public stock markets are tough on thinly traded stocks. Once a few financial “boos and tomatoes” are cast your way, being on stage is a lot less fun. It can be sole crushing for Founders who struggle under the weight of normal tech startup challenges, plus the additional public company overhead that includes Investor Relations, the cost of regulatory financial disclosures and annual financial statement audits, direct legal exposure for the CEO/CFO, and public disclosure of company details served up for your competitors.


Public markets are subject to broader equity market mood swings, regardless of any progress a tech startup is making in executing on its business plan. The tide goes in and out on all stocks. It is not uncommon for a thinly traded tech startup stock on the TSXV to take a hit after issuing a good news press release. The hit comes from the tech startup attracting attention to itself when shareholders are in a restless and grumpy mood. There is also something to the old saw that share prices rise on rumor and sell on public disclosure. The tech startup is forced to publish a press release on material events as they occur, so it’s a bit of a trap – but in the long term any good news will be reflected in the share price.


With a thinly traded TSXV stock, the concept of a “liquid exit” for the Founders (as anticipated when they went public) can be more of an illusion than a reality, even after escrow restrictions on their personally held shares are lifted. Thinly traded stocks are notoriously volatile. Any order from a Founder to sell a stock needs a buyer on the other side of the transaction, and if there are no buy orders at the current price (thinly traded), but a stink bid exists at a lower price, down the share price goes. If this trend continues, shareholders can lose faith, despite a string of positive press releases. Compounding the liquidity problem for Founders is a requirement to disclose personal share purchase and sale transactions on public Insider Trading reports. If shareholders are already nervous, seeing the CEO bail out of the stock can be taken as a real danger signal. If the share price is rising in better times, selling insider shares can be interpreted as the CEO taking a few chips off the table to enjoy a well-earned lifestyle reward. It’s all in the spin and timing.


The stock market is an emotional beast, driven by fear and greed as well as business fundamentals. At any point in time, stock markets can have difficulty measuring a stock’s true value. In the long term revenue growth and profitability will be accurately reflected in the share price for even thinly traded TSXV stocks. Bargain hunters may realize that undervalued shares of a thinly traded stock are out of step with its business fundamentals, and eagerly buy shares that fall to a certain “floor” level. Founders with thinly traded shares should have their day in the sun if they focus on business fundamentals rather than the share price. The key is to ensure the Company stays in the game by not running out of cash. Then progress will be rewarded, but it may take a lot of patience. Warren Buffet once said being a successful investor doesn’t take extraordinary intelligence, but it does take extraordinary patience.



Exit4 - Mature IPO on Senior Exchange


A lot of public stock exchange behavior under the “Exit3” heading above also applies to senior stock exchanges like NASDAQ and TSX, but the hazards of thinly traded stocks are generally left behind when graduating from TSXV to a senior exchange.


Founders with a bold vision to grow Unicorns ($1B valuation) can see their dreams come true if the stars line up properly. Companies that join the Unicorn club have only done so after grinding through the same ups and downs experienced by any tech startup. More than one Unicorn had a foot in the grave not long before their big break. Sometimes hanging on until the sun pops out is a key part of success.


Since my focus is on tech startups, I am not going to spill ink on the process of maturing from a tech startup into a Unicorn. However it is worth noting that back in 2020-21 the sun was shining on BC Unicorn valuations (some private, some public). Though the clouds are back today, it can still be inspirational to look at these examples of wealth created by BC talent:


AbCellera (Dec’20) US$5.3B valuation at IPO on NASDAQ – Using Artificial Intelligence to zero in on COVID19 antibodies (how’s that for being in the right place at the right time!).


Galvanize (Dec’20) Acquired by Diligent Corp (NY) for ~US$1B – Software for governance, risk management and compliance – used to help bust drug cartel fraud, and mitigate money laundering at casinos.


GeoComply (Mar’21) A private investment from Blackstone valued the company at >$1B – geofencing technology used by newly legalized sports betting to ensure bets are placed within state and provincial regulated boundaries.


Dapper Labs (Mar’21) Raised US$305M at a unicorn valuation - Online marketplace for “digital collectible” non-fungible tokens (NFTs) based on blockchain technology.


Thinkific (Apr’21) IPO raised $160M, but immediate share surge placed the valuation in unicorn territory – Software platform for online course creation.


Clio (Apr’21) US$110M raise at a $1.6B valuation – Software for law firms, which have historically been technology laggards.


Trulioo (Jun’21) US$394M raise at a US$1.75B valuation – Software for online identity verification.


Visier (Jun’21) US$125M raise at a >US$1B valuation – Software for workforce analytics.


Blockstream (Aug’21) $210M raise at a $3.2B valuation – Crypto company.


Nexii (Sep’21) $45M raise at a >US$1B valuation – Developed a new building material called Nexiite that is a low carbon alternative to cement and concrete.


Semios (Sep’21) $100M raise at >$1B valuation – Agtech company using sensors and data to monitor crop health.


Copperleaf (Oct’21) $15/sh IPO on TSX ended at $24/sh on the first day of trading for a $1.3B valuation – Software that helps utilities manage critical infrastructure and make optimal decisions on how to allocate scarce budget resources.



Exit5 - Orderly Windup of a Failed Startup


Another very common type of exit for tech startups is (rather unfortunately) a corporate windup. It is a stressful time. The tech startup is not only out of cash, but the Founders have been running lean for months. In these conditions, I have a great deal of respect for CEO’s who value relationships with their shareholders, employees, suppliers, and financial partners enough to make an effort at a fair and orderly corporate windup.


A private tech startup doesn’t need a formal receiver to complete a windup. That process is for large or public corporations with angry shareholders and lots of legal exposure. If there is no cash and no assets (especially IP) to fight over, there is usually not much conflict involved in the windup of a failed tech startup. Quite simply, there is no fight if there is nothing to fight over.


The legal requirement during an orderly windup is for the tech startup Board and management team to act in the best interests of all shareholders (vs. the interests of a few controlling shareholders). In meeting legal and regulatory obligations, there are still a few areas to pay special attention to before turning off the lights.


Debt holders with specific security claims on assets have to be taken care of as a first priority.


Directors and Officers should be kept out of harm’s way by paying out all employee salary obligations including vacation and severance pay, and by paying out all obligations to government tax authorities (especially payroll remittances, GST, PST, and any corporate taxes payable).


If the tech startup has taken advantage of BC’s 30% EBC (Eligible Business Corporation) tax credit to attract shareholders, AND it is winding up before those shares have been held for the minimum 5 year period, then technically the 30% tax credit has to be repaid back to the BC government. In reality, there is typically a negotiation with the BC regulator. As a starting point in the negotiation, the 30% EBC tax credit can be deemed to be earned on a pro-rata basis from the share issue date to the windup date, as a percentage of the 5 year hold requirement. That means only a portion of the 30% tax credit each EBC shareholder received would have to be repaid to the BC government. If the tech startup has been diligent in its annual EBC filing obligations, and the windup doesn’t generate a return to shareholders who received the EBC tax credit, I have seen the BC government regulator forgive 100% of the “unearned” EBC 30% tax credit. So under this scenario the EBC shareholders would get no proceeds on the windup, but they would benefit from not repaying any of the 30% tax credit they received earlier.


Any remaining cash should be distributed fairly among suppliers as long as it lasts. Normally at this point there isn’t much left for common shareholders.


The final issue is how the IP ownership is handled, which can be the one remaining asset of value in a tech startup. I have seen the IP ownership transferred from a windup situation to a new company run by the same Founder CEO, to take on a new life. If done fairly, this is a better fate than seeing the technology buried and forgotten. The technology is still alive and jobs are being created. It can be a bitter pill if early risk taking shareholders are washed out / bought out for pennies by the last money in, leaving early shareholders with no stake in the future commercialization of technology they helped to finance. Life isn’t always fair, but I mustn’t grumble.



No Exit - Lifestyle Business for Founders


The final option for Founders to consider is a non-exit, This is quite rare with tech startups, but it can be done if talented Founders bootstrap without relying on outside investors who expect a timely exit. This path means the tech startup Founders have absorbed the costs of developing a tech-driven product or service, and the costs of finding enough customers to have emerged from “cash burning darkness” into the “daylight of profitability”. That is a very significant achievement.


There are two constraints. One is how long the Founder’s technology niche remains defendable. A Tim Hortons franchise restaurant in a good location is going to be around long enough to see a deceased Founder pushing up the daisies. Software services and tech devices typically have a limited life, unless the Founders can innovate fast enough to stay ahead of the competition and evolving technologies. No guarantee of long term success there.


The other constraint to a “lifestyle business” choice is the absence of a lumpy cash reward that other exit options give to successful Founders. A lifestyle business is like an annuity where cash generated in the business can be drawn out slowly over time (through a mix of compensation or dividends), but there is no “I just won the lottery” euphoric moment. On the positive side, by avoiding outside investment, no VC is going to ask a Founder to vacate his chair. When all Founders agree they are ready to step back into retirement, a lumpy cash option becomes available. The Company can be sold to an outside investor, or a group of employees can arrange to buy-out the Founder shares, and become new joint owners to carry on the legacy.



Conclusion


There are several different paths to a tech startup exit, but all successful exits involve Data Room preparation, and relationship building with carefully selected potential investors. This work can be started in the early days, and accelerated with the help of expertise like a Fractional CFO, an M&A Advisor, or a Board member with bandwidth and M&A experience.


Founders should be realistic about their strengths and weaknesses, and plan their exit accordingly. If egos are in control, a wise Founder will hire the talent needed to fill holes in their organization, allowing them to manage what they are good at. Accepting any VC money means the Founders have likely passed on an early exit opportunity (due to VC’s having a veto over change in control, and their bias for a 10x “home run” return). Accepting VC money over ongoing financing rounds means the VC group gains leverage to force changes in the management team, including inserting a new CEO who they believe can scale up to their minimum $250M valuation target.


Exit strategy is not a one size fits all situation. There are different exit options, each with its own strengths and weaknesses. Perhaps the most important aspect of exit strategy is timing. Unicorn valuations of 2020-21 are now in the rear view mirror, and it is back to the basics for most tech startup valuations. In the current environment, Founders are well advised to conserve cash and get lean until they see signs that the sun is emerging from behind the clouds again. Proceed with caution. You can’t win if you aren’t able to stay in the game.



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