The Art and Science of the Small Exit

Is the “era of the small exit” upon us?

I haven’t looked at any data to determine if smaller exits are becoming more common – I would venture to guess that they’re becoming more public by virtue of the publicity surrounding Web-based startups. But regardless of the past, opportunities are growing for smaller exits, and trends will likely point in that direction.

Y Combinator and its subsequent “incubator” programs like TechStars and others, popularized the small exit by providing small amounts of capital, laser-focusing entrepreneurs on launching products, and turning a number of those companies into quick exits.

I think there are quite a few people – in the startup and venture worlds – that look down upon, or largely ignore small exits, but the reality is that they can be bigger wins for people (particularly the founders) than exits from venture-backed startups.

But don’t assume that a small exit is any easier.

For starters, companies that exit successfully in the $5M-$10M or less range (my impromptu definition of a “small exit”) generally can’t raise a lot of venture capital to get there. That means succeeding on a small amount of angel financing or bootstrapping. Neither is easy. Mark MacLeod has a great interview with Defensio founder, Carl Mercier, about his recent sale of Defensio to Websense. Defensio was bootstrapped using Carl’s money from a previous startup — insanely tough to do and insanely risky. The interview does a good job at looking inside the mindset of a startup entrepreneur aiming for a “big win, small exit.”

So what’s it take to run a bootstrapped or angel-backed company and have a “big win, small exit”?

1. Remember, strategy counts. Just because you’re running a small, bootstrapped startup doesn’t mean you ignore strategy and planning. In fact, you have to be more strategic with everything you do, because the margin for error is considerably smaller. In this case, your strategy has to be focused on an acquisition. I didn’t say “a quick flip” but ultimately it’s very unlikely that a bootstrapped or angel-financed startup is going to IPO. So a win means being acquired.

   Focusing strategically on an acquisition for a bootstrapped startup means you have to really have the perfect fit with the acquirer. They probably won’t be buying revenue or customers – they’ll be buying technology, people and opportunity. So look at the following things:

   • List of potential acquirers.
   • Past acquisitions of those companies.
   • Fill an immediate need with top quality technology.
2. Go for quick traction. Gaining immediate, quick traction is important. Revenue is less important, because it’s unlikely you can scale revenue on your own to the point where you want to be acquired for a multiple on that revenue. So quick traction is key – it gives you the leverage to build a toehold in your market, get enough customer feedback to iterate quickly, and become recognized as a player.
3. Get on people’s radars early. Carl mentions that he had very early “get to know you” conversations with Websense, which later evolved into acquisition discussions. That’s important. Having identified the potential acquirers and what they’re looking for in the perfect fit, it makes all the sense in the world to build bridges with those companies. Get on their radar. Bigger companies like to know who is out there, what they’re doing and you want to feed them the story, and tell it on your terms.
4. Small doesn’t always mean quick. You can’t assume that a small exit is a quick flip. This is important, because if you focus on nothing but a quick flip and it doesn’t materialize you’re in a heap load of trouble. You want to be strategic – identifying acquirers, learning about them, getting on their radar – but you don’t want to put the cart before the horse. Ultimately you have to find ways of building a legitimate business that you can sustain for a few years, otherwise you’ll die before your time.

   And remember, a small exit doesn’t necessarily mean a crappy take for the founders. Three founders exiting at $10M with no investment is just as big a win (if not bigger) than a $50M exit with $5M invested.

5. Run extremely lean. I suppose this is obvious, but it’s worth repeating. Carl mentions paying $270/month for rent. That made me laugh out loud! But it shows you how focused he was on running a successful business. It shows you how he was thinking long-term about survival, all the while looking for the right opportunities to exit at the right time and right price.

We will continue to see more and more “small exits” over time. For a lot of companies it makes the most sense – and I think it gives startup entrepreneurs a great opportunity to go through that experience, learn a ton, and come out swinging for the next round. And I don’t think it’s a debate between venture financing and angel financing or venture financing and bootstrapping – I think it’s a question of what’s best for the company. Some companies are more likely to require financing, others won’t. Some are designed for a $100M win, others are built for a $10M win. You have to know what’s right for your company, and build your plans accordingly.