OnHollywood: Panel on Exit Strategies for early stage companies - Buy, Hold, Sell

Howdy! I finally managed to clear my schedule to make it down to OnHollywood in Los Angeles for the day in order to check out some companies and catch the presentation of co Userplane. It gave me the opportunity to attend a few panels, including one that is close to my heart regarding early stage company exits – and .

Michael Montgomery, the President and Head of Media Banking of Montgomery & co, was moderating this panel on “Buy, Hold or Sell” – which is a very common question going through the heads of Web 2.0 entrepreneurs. According to Tony Perkins, Michael was the banker on the Intermix/NewsCorp deal.

On the panel were (in the picture, from right to left):

• Michael Montgomery
• Jason Calacanis, who sold Weblogs Inc. to AOL.
• Tim Draper, from Draper Fisher Jurvetson and an investor in Skype and Baidu, explains that he never worries about exiting his companies once he has invested. It is a similar statement you would get from a Sequoia or Kleiner Perkins: “Just build great companies, exits will take care of themselves”.
• Josh Resnick, co-founder and President of Pandemic Studios, a gaming company in base in Los Angeles that went through a partial buyout with Elevation Partners.
• Mark Stevens, a Partner with Fenwick & West, who represented a number of technology and game companies as corporate counsel.

Michael asks how selling his/her business comes to the mind of an entrepreneur, and what are the key questions he/she should ask themselves. Jason explains that he has been around the block and built a big magazine business that crashed and burnt, and really appreciates the “basic” driver of a first time “cashing out” entrepreneur: putting his family’s future to rest with a nice wad of cash in the bank. Josh explains that their decision to sell was motivated by a mix of personal risk mitigation (taking some cash off of the table) and getting the right capitalization to the company. Tim Draper has a “Don’t sell” approach, encouraging his entrepreneurs to stick it out. He also ventures that large Internet companies are acquiring startups these days as a result of their inability to release new products/services because they so dramatically cut their R&D budgets during the dot-com bust. He therefore considers that the current early stage M&A frenzy is just “a moment in time” as AOL, NewsCorp/FIM,… rebuild their production capabilities. Jason adds (very rightfully) that large companies are also able to monetize advertising real estate so much better than small ones – giving the example of Weblogs Inc whose traffic has quadrupled since the AOL acquisition.

Mark Stevens points the to the potential conflict of the entrepreneur who is keen on taking an early opportunity, whereas the VC would rather keep the company rolling and scale – and almost always has a veto right on a sale. This explains why termsheets nowadays either get rid of this veto right completely, or provide minimum return levels above which the veto right can’t be exercised (note that this is only something that can be negotiated if there is some competition on the deal between VC firms). A solution to mitigate the risk of founders, and provide some required cash, is to have investors offer a partial buyout of founders for small amounts that are still meaningful to first timers.

Tim states that Sarbanes Oxley is preventing early VC-backed company IPOs, and therefore there is a change taking place in the exit landscape, where private equity firms step in and buy out investors and founders at least partially – sort of as an alternative to a public market float.

Jason relates to the process he went through at Weblogs Inc, leading to the AOL exit. As he saw more blogging networks being formed in 2005, he realized that he need to capitalize his company further and was prepared to raise additional angel capital (Jason states that he does not want to raise capital from VCs because he sees them focusing on serving their Limited Partners not entrepreneurs they invest in – which is not totally true IMHO). And I suppose that he was about to explain that he considered a sale as well – but he and Tim are going on at each other on the merits of getting investments from VCs or individuals.

Tim’s point on the subject is that individual investors are great for short term plays, but VCs will be the ones to stick around for a long time and have the resources to invest large amounts to scale companies.

On valuation metrics, Josh explains that Elevation Partners paid a premium to EBITDA multiples of his industry.

On selling one’s business, Mark explains that entrepreneurs need to be focused on running the business, and making decisions that make sense for the standalone entity. Changing the execution of a company in order to make it more compelling to an acquirer can be a (near) fatal mistake. Another issue that has limited the exit potential of companies are the long term liabilities of the business: long term contracts and leases, etc. Jason explains that he made sure that all his contracts could be cancelled on the 30–day notice.

Jason comes back to the issue of alignment between VCs and entrepreneurs: successful VCs have built personal wealths in the tens or hundreds of millions of dollars. Therefore having a VC partner suggest to entrepreneurs that they should not accept a payout of $5, $10 or $20M for themselves leads to a tricky discussion.

Tag: OnHollywood