Striking Gold on the Way Out

Entrepreneurs can always explain why they launched their businesses. Formulating an exit strategy can be a lot tougher, as venture capitalist Greg Case explains

Chew the fat with successful entrepreneurs, as we here at BusinessWeek Online do regularly, and sooner or later, it's all but inevitable that the people being interviewed will give thanks for whatever simple twist of fate opened their eyes to an opportunity. They saw the need, entered field, took the risks, invested the effort, and their outfits' prospered asa result.

But what about reaping the full harvest of one's labors when the time comes to sell the business and move on. While business coaches, professors, and accountants all stress that the smart entrepreneur never loses sight of an exit strategy, the truth is that many business founders and owners find it almost impossible to pull up stakes. It might be that their creations would fold without them, or that concern for employees' security inhibits owners from selling to outsiders, who might trim payrolls, move the outfit to another area, or demand longer hours for the same money. Or could be that the economy's habitual ups and downs leave no easy and proven way to turn years of effort and experience into cold, hard cash.

These were some of the questions BusinessWeek Online's Edward Popper had on his mind when he sat down to discuss exit strategies with Greg Case of venture-capital outfit Apax Partners. Edited excerpts of their conversation follow:

Q: How big a part should an entrepreneur play in finding potential buyers and the process of selling a business?


Management typically has a lot of things on its plate -- and they're only going to sell their business once, which means they probably haven't had a lot of experience. My view is that you want management to continue to focus on building the business, because, if a sale doesn't happen, you don't want them to have been distracted, and the business to have suffered. It's typically best to hire a banker who is more knowledgeable than the management team about the process of selling. It's a good way not to distract your management.

Q: Speaking as a venture capitalist, when do you start planning the exit strategy? What thinking goes into your plans?


Before we make any investment as a private-equity investor, we do a fair amount of work trying to understand what sort of exit alternatives might exist for us and for the company. We try to judge whether it's a business that has the characteristics to become a public company over time. Is it a business that is more likely to become of interest to a strategic acquirer in a certain sector of the market? Or is it a business where the most likely outcome or exit for us as an investor would be through a recap or refinancing of the business somewhere down the road?

Q: Can you give me an example of a company that you sold to a strategic buyer and how you understood your exit alternatives at the time you invested.


Greenbacks is a company that we invested in probably six or seven years ago. It's a chain of dollar stores, you know one of those places where all the merchandise is available for a dollar or less. You've probably seen those stores at lots of places around the country. Greenbacks happened to have that retail format out in the intermountain region. That's the Rocky Mountains, from the Salt Lake City region down into Denver and out into Arizona.

The management team, having built a number of stores, and having proved this concept worked, needed to find a patient partner that could give them gross capital so they could build the business to the next level. So we invested and management executed. When we invested, the company had close to 20 stores. By the time we sold it, they had almost a hundred stores. So they grew the business very significantly.

Dollar Tree (DLTR ) is a public company that controls large numbers of stores in different geographies. They made the decision that they would rather buy an existing company than build their own stores from scratch in order to get into that particular geography, so they paid a nice price [$100 million] for Greenbacks, so we and the management team sold our shares. That's an example of the sale of a private-equity backed business, built by entrepreneurs, to a strategic buyer.

Q: Earlier, you listed three possible exit strategies, and one of them you called "recap." Can you describe that?


There are a lot of those going on right now. In essence, it works this way: You have a company that's been backed by a private-equity sponsor and that is being sold to a company or entity set up to acquire it with money from another private-equity sponsor. That represents a way for the initial private-equity sponsor and the other shareholders to either sell all the business or a significant portion of the business to a financial-equity sponsor.

Q: Lets say a business owner was interested in selling out totally in order to retire. Would selling the business to a private-equity sponsor provide the best chances to cash all the way out?


If the whole team that built the business wanted to cash out at the same time, that would be a highly risky deal for a financial buyer such as ourselves. Unless we had a group of people to bring in and run it, we would be less inclined to [invest in that company]. If you want to get complete liquidity as a management team, the most likely way to do that is through a sale to a strategic buyer.

Q: You've just described, a recap and a sale to a strategic buyer. If neither of those options are appealing what other exit strategies exist.


The third way of attaining some liquidity is through an initial public offering (IPO), but the private-equity investors and the management team aren't going to get liquid. They may have an opportunity to sell a small percentage of their shares in the IPO, but it typically takes a fair number of years to openly sell off an entire position in a public company. I feel that that's really more of a financing event than it is a liquidity event.

Q: How should the owner of a private company who is coming to the end of his career cash out of his business if no strategic buyers seem interested?


You typically are going to have to take a look at strategic acquirers or you are going to have to see whether or not you are going to have an opportunity to refinance or recap the business. Or you wait. There are certain times in the world where you simply can't sell. You'd like to sell, but you are unable to do it because the strategic buyers might not be interested. The financial markets might not be interested, and in those cases, you just have to sort of hunker down, work your way through it, and find a better time to sell.

Q: When it comes time to exit, how do you decide on your selling price?


The simple answer is that the market dictates. We may have an opinion as to how much a company is worth, and then we go test that opinion by talking to strategic acquirers or talking to bankers, who then give us feedback about what the market would value the business at. So it's less relevant what we think the business is worth -- and it's more relevant what the community of buyers might be willing to pay for that business. The community of buyers are strategic acquirers, other private equity firms, and/or the public market.

Q: How large do you think a company has to be in order to consider an IPO?


It varies company to company, and it varies market to market. When you had a bull market for technology stocks back in the late 90s and in 2000, going public was happening very quickly -- long before anybody would typically expect to be able to. Unfortunately for a lot of folks, those values were not sustained. For the past couple of years, you couldn't get your company public even if you wanted to, because there was no demand for new public stocks.

Now, that's changing. Apax has had a couple of our companies go public in the last six months, and I think that reflects the fact that the market is strengthening.

Q: So, in today's market, a company has to be a larger to go public?


It depends on what particular industry that company participates in, and it also depends on where you are in any point in time in the public market. There are certain times when bio-tech companies might be hot, and then it's relatively easy to get a biotech company public. And there might be other times where it's impossible to get a biotech company public, because nobody wants to buy stock in that sector. The answer to your question is: It depends on what industry you're in and what the public markets think about that industry at that moment in time.

I'll give you an example. We've just had one of our companies go public in November, a company called Tessera Technologies, which provides a technology that's used by semiconductor manufacturers -- chip manufactures. Tessera is a relatively small, very profitable business. We basically invested in a couple of engineers about 13 years ago, who took our money and used it to write a business plan. So it's been a long time. The company got public in November. It's relatively small, as I said, but it's in a space that people were very interested in -- emerging semiconductor-related technologies. So on that basis, the company went public, and the stock has done quite well. It really does depend on the kind of business you have and the public market's perception about that kind of business at any point in time.

Q: What is the most important or most common pitfall to avoid while exiting a business?


The big thing is to make sure management isn't distracted by all the meetings and conversations that take place when considering an exit. You want to make sure management has the opportunity to continue to focus on running the business because that's the most important thing.... If management is not focused and the business deteriorates, it's not going to be in anybody's interests.

Q: How do you deal with employee fears about job security that may develop as the company changes hands?


In this country, as in most countries where there's a capitalist system, people understand that companies need financing to grow, and that part of the whole life cycle of a business is raising financing and raising money for investors and, ultimately, getting liquidity for investors and share holders…. There are investors who are in the business when it's a private company, and there is a different set of investors when it's a public company -- that's part of the process of a business growing up.

Now, when the company is set up to be acquired by a strategic buyer that can, at times, be unsettling. I think you need to be clear on what the objectives are, why it's time to sell the business, and how [the employees] can benefit from that sale. You try to take as much uncertainty out of it as you can. But there's no one right answer on that one.

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