If you’re an entrepreneur planning to raise venture capital funding, you’re probably focused on the fundraising process itself, and rightly so. It’s often difficult to get the funding you need at the terms you’re looking for. However, even before you raise any funding, you should also be giving serious thought to your exit strategy.
VCs never make an investment without considering the exit – in other words, how, what and when they will get paid for the equity they own. This generally occurrs when the company is acquired through an M&A deal or goes public in an IPO. Entrepreneurs seeking VC funding should also think about the potential value of the company, and the founders and management equity stakes, in a variety of reasonable exit scenarios. In particular, you must consider how a proposed term sheet will impact your equity value given a reasonable exit scenario.
For example, consider the effect of dividends. In a recent post, we discussed the effect dividends can have on the upside for VCs and entrepreneurs. Specifically, in a downside situation (an unfavorable exit), dividends strongly favor VCs, particularly if the exit is delayed. Depending on the timing and terms, the effect is often significant.
Similarly, other VC terms such as liquidation preference and participation may have a huge imact on the amount recovered by entrepreneurs at exit, or no impact at all depending on the nature of the exit. If the company goes public, these terms do not affect the value of the equity owned, while in an M&A deal they are vitally important.
In summary, even before raising VC funding, you should consider the effect that your planned exit strategy has on the value of