A business’ growth is not linear throughout its lifespan and founders will often be faced with high-stakes dilemmas as to how they should continue their entrepreneurial voyage. Whether they’ve bootstrapped their business and only grown it organically, or whether they’ve already gone through one or a series of equity financing rounds with angel investors, venture capital, or private equity, founders are often faced with the opportunity to either scale their business by raising additional funding or to exit completely by selling privately to a financial or strategic purchaser (through an M&A exit transaction). This dilemma especially reoccurs for founders of high-growth tech startups and scale-ups.
In this blog post, we’ll show you the founders’ and investors’ respective perspectives on these two options. Based on this, we’ll be able to outline concrete criteria and advice to guide entrepreneurs through this tough decision.
The Founder’s Perspective
At a high level, founders faced with the sale-or-scale dilemma mainly have to wonder whether they want and are able to lead their business to greater heights, if given additional funding; or whether their time to step down has come. In other words, the options for founders are to either buckle up and take on the next growth-spurt, or cash out on their thousands of hours and hundreds of late nights developing their business.
Given that founders will, even after a sale, often need to stay somewhat involved in their company, the question is of course more complex than that. Let’s have a look at the main pros and cons of each option.
Pros and Cons of a Financing Round for the Founders
Pros of financing rounds include the following:
- Founders are largely left in control of their business. In that context, their day-to-day lives will usually stay similar, to the exception of a big increase in the company’s liquidities to allow for a growth-spurt.
- Financing rounds typically allow founders to restructure the business’ leadership organigram and to hire teams for each function. Thus, they are left with more time to concentrate on leading the business rather than dealing with low value-added tasks.
- Newly enabled synergies in terms of business-leadership expertise and operations can drastically help the company’s development.
On the con side:
- Founders who accept funding prolong the intensity of their lives for usually at least several years. Furthermore, scaling a business means scaling the complexity tied with its leadership. Let’s be honest though, many founders will see this as a pro…
- Except in rare instances, none of the investors’ funds will flow to the founders. Accepting a financing round therefore means that the founders’ cash-out is deferred until a later time, albeit potentially for a greater amount..
- Investors will require some control over the company’s leadership and founders could feel as though their investor(s) are constantly “breathing down their necks”.
Pros and Cons of an Exit for the Founders
The main and obvious pro of an exit is that founders get to reap the benefits of their years of hard work by cashing out. The corollary of this is that they also have to abandon their baby, which can be a harsh experience.
More often than not, purchasers will request that founders stay involved in the business, at least for a transitional period. This collaboration can be seen as an advantage by often allowing founders to maximize their yield if they hit milestones designed to incentivize them. It will however usually be very difficult and painful for founders to work in their own business under the leadership of the purchaser’s executives.
Finally, exiting the business means surrendering the right to any value created by the future growth of the business. You could illustrate the founders’ position by that of a gambler having won a round of roulette and wondering whether he should play another round or cash out. The founders’ appetite for risk will therefore often be a determining factor in the decision.
The Investor’s Perspective
From an investor or purchaser’s point of view, the difference between a financing round and a founders’ exit is mainly twofold. Indeed, it generally defines:
- whether they hold the company partially or in its entirety after the transaction;
- whether the price that they’re paying will flow in the company (in a financing round) or to the founders (in an exit).
Pros and Cons of a Financing Round for the Investor
The financing round has the advantages of (i) securing the founders’ continued collaboration and interest in the business and (ii) ensuring that the investor’s funds will serve the target’s growth and not just flow to its founders.
On the other hand, the founders will almost always (rightfully) refuse to surrender a lot of control over their business. Other than the mere uncertainty tied with a third party leading the business, this means that the (strategic) investor could also not fully integrate the target in its operations and synergize its group.
Pros and Cons of a Founders’ Exit for the Investor
On the other hand, purchasing a business means full control over it. For a strategic purchaser, this allows big internal synergies and cost optimization, sometimes to the point of absorption of the target in other entities affiliated to the purchaser.
For strategic purchasers, the continued involvement of the target’s founders is often less crucial as it has its own industry experts. A transitional period is however often requested, where the founders remain involved to ensure that the purchaser can adequately take over the business with minimal leakage of value and know-how.
For financial investors, purchasing a business entirely is usually very dangerous as this type of transaction makes it difficult to secure the founders’ continued commitment. Financially driven acquisitions are however not uncommon, usually in one of three constellations:
- The target business is mature enough to be autonomous, meaning that the loss of its founders doesn’t prevent it from thriving. In this situation, the purchaser will often request assurance that the target’s key personnel is secured to ensure business continuity and further growth.
- The founders are requested to stay active in the business, in which case they will often be incentivized financially (for example by the setting up of earn-outs on part of the purchase price).
- The financial investors have a team of industry-experts that will take over from the founders and be adequately incentivized to ensure business continuity and growth. This constellation is frequent when financial purchasers specialize in a specific industry and can “recycle” their experts on successive targets (arguably though, there is a fine line between this case and a strategic purchase).
Criteria based on which to Decide
Here are some of the questions that founders could ask themselves to guide their choice of the best option for their business and themselves:
- Do they, as business leaders, have the capacity and will to push their venture to the next level?
The pandemic has shed light on the importance of mental health and the struggles of many in this regard. Leading a business is a draining profession and founders are regularly led to flirt with their limits, often close to burnout or other difficulties. However important one’s career and business are, one’s (mental) health and the stability and balance of one’s personal life should always be a guiding star in professional decisions.
- Does their business, namely based on the market that it evolves in or the new markets that it could tap into, have the potential for steep growth thanks to additional funding?
- Are those target markets interesting, both objectively and subjectively?
For example, if a company was founded in the field of mountain sports technology because of its founders’ passion for trail-running and rock climbing, moving towards soccer or hockey could be a dull perspective.
- How big is the founders’ appetite for risk?
- Are the founders in need or want of financial resources in the short term?
Exiting your business means a substantial payday, which can enable the purchase of your home or new entrepreneurial endeavors. On the other hand, some founders are happy with their way of life and have no specific entrepreneurial projects in mind, meaning that cashing out in the short term is not imperative or even wanted.
- Is the business well prepared for an exit?
If the company is well held and prepared for an exit, then the price that purchasers are willing to pay can be significantly higher. Should your business not be optimally prepared for an exit, it could be interesting to delay the transaction and take time to prepare.
First off, if you’re in a position to decide whether to raise funding or exit your business, congrats! That’s a truly great place to be as a business founder and shows how much you’ve achieved.
Whatever you end up doing, we strongly advise you to prepare your company for an exit as well as for future financing rounds.
In any case, mapping out your wants and needs, as well as those of your prospective investors or purchasers, and the interest of your company can be extremely enlightening. No two deals are the same and – whichever option you chose – all parameters can be adapted to best fit the specific situation.
This blog post has been willfully written in the context of a binary world, where the two options available were only selling or undergoing an equity financing round. In real life, you may have other options, for example, to differ the dilemma by signing a convertible loan. Such a transaction would allow you to test the growth potential, before deciding whether to exit or grow even further.
Finally, whatever transaction you’re envisaging, the relations and feelings with your counterpart are very important. Always remember that no deal is always better than a bad deal…