The Exit Strategy: What investors look for in a business

When investors sit for pitches, they expect to be told about an exit strategy. This includes a tale of future acquisition or IPO.

Nowadays, these contingency plans have become more creative. Take, for example, BodeTree.

In an article about creativity being a hook for investment, co-founder Chris Meyers unveiled the unconventional route he took.

“We started with two verticles: franchising and banking. This move enabled us to begin to isolate the value of each respective channel and package it for a potential sale.

“Next, we expanded the business through acquisition so that we had the cash flow necessary to support the company independently. At this point, we were in a position to do two things.

“First, we could sell our banking channel as-is at a valuation that made sense for more buyers. Second, we managed to retain the franchising segment of the business, which was profitable. This allowed us to offer investors an outsized and, far more confident, return.”

Tim Smallbone leads Inflexion Private Equity’s enterprise team. In The Supper Club’s latest guide, Planning for Scale, Sale & Beyond, Smallbone shares what he would normally look for in a business.

“We look at each company on its merits as businesses will have different drivers in their respective markets. But one important matter is whether there are any obvious vulnerabilities, namely issues out of their control such as forthcoming legislation changes.”

These are a no-go for many investors, he explained, as it’s a variable you cannot control.

He added: “Beyond this, the business must provide something worthwhile for customers, as this leads to decent margins and that’s crucial. A diversified customer base is equally as important, since overreliance can be risky.

“If we see a rhythm of profitable growth backed by a solid management team, we will take a closer look. We want strong net margins of 15-20% and robust growth, but don’t look for specific sectors or types of business we’re open to different opportunities.”
There must also be an element of continuity, whether it’s the founder or someone else who knows the business intimately and is able to manage change.

“Finally, we look for good alignment with us as the investor so tend to avoid management buy-ins, as alignment and continuity can be trickier there,” he explained.

A possible high valuation is also a factor in deciding which business to go with. So profits are important, as well as how they’ve been maximised.

“We look at the predictability of earnings and rates of growth, making recurring revenues particularly attractive,” Smallbone said. “Valuation is an art rather than a science and so we look for the potential of a business where can it go, and is management sufficiently motivated to drive this?

“Ultimately, we are only the temporary owners so we will think about the eventual exit and how to get there. Could it be an IPO or sale to a strategic trade buyer, for example ”

Smallbone suggested that founders look beyond capital. What else do they want from an investor?

One of the most common mistakes founders make, Smallbone explained, is failing to tap into an investor’s knowledge.

“Part of our role is to help founders understand the range of options available to them,” he said. “While our role is to provide capital, we can also introduce lawyers, accountants, and corporate financiers to help them make more informed decisions.

“Another mistake is not thinking through succession planning. Founders can get caught up crystallising value and getting the deal done without thinking about who will take the business forward after they step away.”

Research reoccuringly coughs up the fact that too few companies think of succession planning as important. Legal & General suggested it was particularly prevalent amongst family businesses, where 58% don’t prepare to pass on the baton.

Talking about the private equity field, Smallbone explained that the need for a change at the top was an opportune moment for a deal to be made.

“If you want to exit within five years, that is a great time to bring on board a backer who can help you get out with two bites of the cherry,” he said. “A key point is the founder’s willingness to remain involved for a period of time if the founder wants a speedy exit, trade is a better option than private equity.”

This article was originally published on Real Business.