Exit Strategies And Valuations
One of the most often overlooked components of a business plan is the company’s exit strategy. You must think from the perspective of the investor reading the plan who essentially wants to know how much capital is needed, what the potential return will be, and when and how they will realize this return. Laying out all of alternatives and giving examples of other companies who have successfully “exited” via merger, acquisition, IPO, or other means is a good start.
It is helpful to show other or similar companies that have successfully exited, and how and why these companies were successful. Did they acquire a large customer base? Did they have high profit margins? It is also important to tie their success to their exit price. Was the exit price based on earnings or the number of customers the firm had at the time or some other means of valuation?
The most common exit strategies in business plans are Initial Public Offerings (IPOs) of stock or acquisitions. While the method of exit is not always crucial, the investor wants to see the decision to better understand the management team’s motivation and commitment to building long-term value. If acquisition is the selected exit path, then the business plan should detail potential companies that might want to acquire the firm. If an IPO is expected in the future, the business plan should document the financial metrics of the company that make it a candidate for this type of exit.
In most cases, investors only make money when the business reaches a successful exit event. As such, it is critical that business plans explain the expected exit, detail why this exit was chosen, and validate a realistic exit price.
Valuations are a critical component of both the entry and exit strategy for investors. A “pre-money” valuation using a discounted cash flow (DCF) or net present value (NPV) model, will give an estimate of the value of the company’s future cash flows in present day dollars. This is based heavily on the assumptions in the financial model, which must be validated. Once the company is operational, a more comprehensive valuation upon exit is needed. This would include a DCF/NPV analysis of actual and future cash flows, and of combination of other valuation methods such as industry multipliers, value per customer, etc. A weighed average of these methods is then used to come up with a final number.