We often talk about what to do for your startup to succeed. But what to do when you have to call it a day? This post is focused on 5 best practices for winding down your business.
Path #1: Acquirer
A typical fundraise takes 3 months and having an extra 3 month buffer is a good idea. So if you are within 6 months of running out of cash and have reasonable doubts about being able to raise, M&A should be top of mind. Chances are your investors will bring this up, perhaps in 1/1 conversations especially if you are at the seed stage and don’t have an official board. Regardless, as a CEO you have a fiduciary obligation to consider that path and study any offer, even if you are not personally inclined towards it. Most entrepreneurs at this point run a parallel process i.e., pursue both acquisition and investment. Most M&As are the result of long-standing conversations. Most good offers are inbound, rather than outbound. Managing a company, a fundraise and an acquisition is a trifecta of work so hiring a banker, especially for the latter, often makes sense. Good bankers take 5-10% of the acquisition value, often with a monthly retainer, but increase the odds of a good acquisition far more than what they charge.
Path #2: Acquihire
If you are pre-series A, even if you have a product fully built, an acquihire is a very respectable exit. Acquihires are much more common in mature ecosystems where there is an appetite to buy a ready-made team rather than hire individuals. In Silicon Valley the $1M per engineer is still held as an adage, but increasingly it comes with other conditions. Entrepreneurs beware — your acquirer may want to negotiate how much cash versus equity they give you or whether they honor accelerated vesting. In fact, if you are pressed against the wall, there may be terms violating the conditions set in your term sheet, which will then precipitate a discussion with your investors. Not to mention the acquirer will have expectations around vesting schedule, role, and title in your new home. A good acquihire holds a similar principle as overall acquisitions, it’s often the result of long-standing conversations so both parties come to a quicker and better agreement.
Path #3: Recap
Recaps are the exception to the rule, failing companies that rise from the ashes. Three key factors for a successful recap: the core team has to continue believing, existing investors have to agree to be diluted, the new cap table must incentivize growth. On the first factor, being undeterred by impending failure is a trait shared by most founders and often early employees. The second factor is arguably the more challenging one. Entrepreneurs seeking to recap should convince their investors that diluting them significantly and taking more money to live another day will eventually lead to a better outcome. The alternative is path #4 about winding down, described below. The third factor is critical because the recapped company must still be able to retain existing employees and attract plus retain new ones. In successful startups founders often own half of the company till series B and there is a 10% optional pool — recapped companies should arguably have similar metrics. Case study: Adaptive Insights grew 20x after their recap, being sold for $1.6B in 5 years.
Path #4: Wind Down
This is the ultimate fallback when founders settle all debts and return any extra capital back to investors. In some cases, especially when liquidation preferences are involved, investors may end up getting most or all their money back while founders, management and employees end up with very little or even nothing. Many VCs tend to then take some of the hit and actually give the company 20% or so of the proceeds. Entrepreneurship is after all a recurring game i.e., the founders may start a new company and potentially work with the investor again, not to mention the wider reputation of all parties involved.
Path #5: Spinout
Most of us associate spinout with a project launched by a corporate or venture studio that becomes its own entity. But small companies also create spinouts, especially if there are very different strategies involved. In those cases the entrepreneur will jettison the part that is most promising into a completely new entity, with a clean cap table, best poised to grow. Podcasting company Odeo was launched in 2005, then reformed as Obvious in 2006, and developed a side project. The side project was shortly thereafter spun out and the parent company continued for a few more years until essentially winding down. The side project is what we call Twitter worth $57B as of writing this article.
Originally published on “Data Driven Investor,” am happy to syndicate on other platforms. I am the Managing Partner and Cofounder of Tau Ventures with 20 years in Silicon Valley across corporates, own startup, and VC funds. These are purposely short articles focused on practical insights (I call it gl;dr — good length; did read). Many of my writings are at https://www.linkedin.com/in/amgarg/detail/recent-activity/posts and I would be stoked if they get people interested enough in a topic to explore in further depth. If this article had useful insights for you comment away and/or give a like on the article and on the Tau Ventures’ LinkedIn page, with due thanks for supporting our work. All opinions expressed here are my own.