Making a graceful exit
Basil Peters’ Canadian company Nexus was on a roll.
The company he’d co-founded with a fellow student to fend off starvation while studying for their PhDs had grown from a two-bit engineering consultancy into one of the world’s biggest manufacturers in the flourishing cable television industry.
The two founders were having a ball. Peters’ thought nothing could touch them.
He was wrong.
In 1990, the US Federal Reserve Bank, concerned about soaring real estate prices, pulled the plug on the junk bond market, which - unbeknown to Peters – was the main source of finance behind his customers.
"They shut down the whole market overnight. They didn’t mean to shut down cable industry construction at the same time, but they did. We got caught in the cross fire."
This coupled with a hefty research and development commitment meant Peters' company for the first time in its history was facing a loss.
One of Peters' board suggested they should sell.
Looking back, Peters is astounded and a little embarrassed to admit neither he, nor his co-founder, nor any of his board (and some had quite a bit of grey hair) had ever discussed an exit strategy for Nexus.
"It was a completely alien idea," he says.
"My partner and I were like most entrepreneurs, we’d fallen in love with our creation; we’d confused our identities with it. We literally couldn’t imagine selling the company."
He still made a tidy packet when they did sell the company to Scientific Atlanta, now Cisco, in 1993. But he was very lucky, he says.
It was the lost opportunity that irked; they could have made millions more if they’d sold the business when it was doing well.
Today Peters is almost evangelical in his passion for making others, be they entrepreneurs or early stage (angel) investors understand the importance of making a timely and, more importantly, an early exit.
He’s a lecturer, a sought-after business speaker and an author of an international top 10 business book called Early Exits.
He’s also an active angel investor, manages an angel fund and runs his own consultancy company, Strategic Exits Corp at home in Vancouver, Canada.
Until now – restricted by a vet wife and a menagerie of animals - he’d pretty much stuck to sermonising on all things exits in North America.
But Unlimited caught up with him at one of his first overseas excursions when he popped over to talk to New Zealand's angel investors about the importance of making an early exit at the 2013 Angel Investor Summit in Dunedin at the end of October.
Nexus taught him a great deal, he admits, but it was still nearly 100 investments later that he began to put it all together and realise the true value of early exits.
"I'm a really slow learner," Peters laughs.
"I had to see the same thing happen four or five times before the light started to go on.
"What I learnt - after being an investor for an embarrassingly long period of time - is investing is easy. It’s getting your money back that’s hard."
Time and time again Peters watched companies he’d invested in wait too long and miss out on far better deals or on doing a deal altogether.
"I came to appreciate if a company misses the ideal time to exit, there’s a very high probability it will never exit; it will fail.
"This is the blinding economic realisation I’m now trying desperately to help other people understand."
Though there are no official figures, from his own experience Peters estimates only about 25% of the companies that can be sold are sold.
"The best time to sell is when everything is going wonderfully."
But it’s also human nature not to think about selling when everything is going well, which is why entrepreneurs and angels alike need to talk about and work out an exit strategy right from the very beginning and not rely on expensive and too often ignorant M&A (merger and acquisition) advisers to help them when they suddenly find themselves forced into needing a sale, he says.
Most angels have portfolios full of companies they’d like to see exit, but very few which do because there's rarely enough focus or effort put into incorporating an exit into the company's overall business strategy, he says.
He pooh-poohs any notion, however, that there aren’t enough buyers: "There are tens of buyers for every good company.
"History will refer to this as a golden era for entrepreneurs because never before have so many entrepreneurs been able to build up such valuable companies on so little capital."
Peters has made a detailed study of the current market and says buying small companies, a few years from starting out, is now the norm for larger companies. Google has said as much in its own presentations.
Take Club Penguin, the game website for 6 to 14 year olds; that was sold to Disney for $US350 million in cash just two years from startup. YouTube was also just two when it sold.
But both were sold for far, far more than the norm, says Peters. North American analytical data shows most companies are sold for less than $US20 million.
But Peters estimates it's even less as prices are rarely disclosed, a fact he laments as it does nobody (apart from the costly consultants involved) any good.
The days of building up large companies through angel investment and multi-million dollar venture capital (VC) deals only to have that capital realised through an IPO (initial public offering on a stock exchange) are gone.
Now larger companies grow by swooping on innovative, smaller companies with proven technologies (but not necessarily any sales) that can enhance their own growth.
This way they cut out the costly VCs, who they see as adding little value.
Given it costs so little to set up a company these days - relative to growing it into a multinational - the risk-reward ratio favours earlier exits, he says.
"Risk and return are always inextricably linked. For most companies, the more you hang on, the more risk there is.
"Sure you could get more, but you have to balance that against the risk. We’ve never seen such rapid competition formed before.
"More than ever there is a chance something will come out of left field and whack you. That’s why 75 per cent of companies that could’ve been sold, never get sold."
Peters has little time for people who speculate what a loss it is for the country when our tech darlings are sold overseas.
Fewer and fewer of the high-growth multinationals are moving companies after they buy them, he says.
So the sale not only injects capital directly into growing a company in its home market it also frees up the entrepreneurs' and the angels' capital for re-investment.
"Think of it as recycling."
We've got far more specialised in our economy, says Peters. Big companies have the skills to scale up from say $US20 million to $US200 million, not to innovate and vice versa for entrepreneurs.
“So the best thing we can all do for the economy is to help entrepreneurs be innovators, to get things working, to prove the concept and then sell the company at the right time to a larger company that will continue to grow it."
Exits are by far the best part of being an entrepreneur or an investor, says Peters.
"It’s when we get paid for all of our hard work and risk capital. Giving birth to a company and growing is very rewarding, but it’s also a lot of hard work.
"The exit is also a lot of hard work, but for a shorter period of time and at the end there’s this really big positive effect on your bank account and, so far, I've never met anyone who didn’t think that was quite a bit of fun."
Exiting the kiwi way
That old adage "businesses are bought not sold," is just that, "old," says angel investor and vice-chairman of the New Zealand Angel Association Marcel van den Assum.
The traditional, build a business and a buyer will come-mentality, just doesn’t work, not in today’s world, he says.
Van den Assum was responding to Canadian angel investor and Early Exits evangelist Basil Peters' call to arms at the recent association summit.
Of the angel investors questioned, all admitted to a pretty dismal record of exits so far.
There have been some, says van den Assum, including television commercial distribution company eBus Media Network, sold to London-based video content management firm IMD earlier this year, wireless charging company HaloIPT to the US Nasdaq-listed mobile technologies giant Qualcomm in 2011 and tech firm Aptimize sold to US corp Riverbed Technology, also in 2011. But there are still far too few, he says.
John Gallaher, investment committee chair for Dunedin’s Otago Angels group, agrees that one of the main problems is both entrepreneurs and their early stage (angel) investors in New Zealand simply don’t start thinking about how they are going to get their money back early enough.
"We’ve got to get more proficient about building a company to exit. We get too fixed on just building a business and it becomes the end rather than the means."
There’s also a mindset that needs to change in New Zealand, says van den Assum. When eBus was sold one headline read: "Yet another tech company sold offshore;" while HaloIPT’s sale was accompanied by: "University sells off wireless technology".
These don’t send a very positive message, he says.
"Our culture is constraining the celebration because it's seen to be selling out."
Gallaher says things are changing and there is increased confidence among investors and entrepreneurs to embrace the idea of an early exit and work towards it.
Steve Silvey, chief executive of Dunedin’s Upstart business incubator, says entrepreneurs and angels need to work together to identify from the get-go where a Kiwi startup fits in; what sort of value this could mean; and how they connect with the key players.
"Angels can work together to do the research. It’s time-consuming and requires good market intelligence, which in turn relies on good networks, but by acting collectively angels can produce a better result."