I recently reviewed a set of investment ready criteria published by a respected Angel Group (not the Pasadena Angels). All the usual factors were there–what problem was being sold, the extent of competitive advantage, the experience of the management team, size of market, etc.  You could quickly infer from the questions that the objective was to find a high growth potential venture to invest in. No doubt the intention was to fund the company,  establish a market position, grow market share and then somehow harvest the venture. What I found remarkable was that the question of possible exit path wasn’t on the list.

Perhaps I shouldn’t be that surprised.  I recall conducting a study 5 years ago when I and a colleague reviewed several hundred VC websites to ascertain the extent to which exit strategies were discussed or requested in investment proposals. Even then I was surprised to discover that over half the sites had no mention of exits and not one had an explanation of the various forms of exit and an indication of what information the VC firm would like to see on the proposed exit strategy. Five years on and I had hoped that we would have gained a much better appreciation of the importance of the exit to the investment evaluation.  It seems I was wrong.

What I find distressing is that we still seem to be locked into a business concept from the 70’s and 80’s where the dominant VC model was to grow a business to a point where it could be taken to an IPO.  In those days the pent up demand for hardware and software meant that any reasonable product could fuel significant growth so an IPO was a real possibility.  Then along came the internet boom followed by the biotech boom and that simply reinforced the conventional wisdom. However, it is very clear now that the days of easy IPOs are gone and so is the conventional VC model.

In the present environment our liquidity options now are very limited, basically the best and most likely path is a trade sale.  If that is the case, then why are we still fixated on building out the business. Surely the question we need to ask is – what form of trade sale is the best harvest option for this venture?  Only then can we deal with the other criteria. Is it not the case that the exit method drives the development of the business?

Before we get tied up in legal and financial due diligence we should be working out the exit. We should be ascertaining how the venture will create value and what type of acquirer wants what they have?  Since there is a fundamental difference between a trade sale based on inherent revenue and profit generation from one based on exploiting an underlying patent or other form of IP, these are critical to an evaluation of whether the venture can be prepared for sale.

Asking about market share, distribution channels, management experience, R&D pipeline and so on, before ascertaining the exit path is clearly asking the wrong questions.