Deciding when to sell shares, raise capital or sell your company
Entrepreneurs regularly ask me when the right time is to raise capital or sell shares. Having worked on hundreds of high-growth M&A deals and portfolio investments, I developed a model to help bootstrapped entrepreneurs think through the question of timing with regard to their own situation. I recently gave a talk for UBS’s wealth management group and put these thoughts into a presentation. I will share a few highlights in this blog post along with several key slides. If after reviewing this you are interested in seeing the full presentation, please click here.
The biggest issue in thinking through the issue of timing is that you have many different unrelated considerations leading to conflicting conclusions such as: “I think the market will grow much more so I should wait. However, I have a lot at risk in the business so perhaps I should sell.” or “Should I sell shares to raise capital causing dilution or manage with slower growth?” or “My revenue growth is fast; but the offer I am getting is high: am I getting enough value for the future potential?” or “I could grow faster but I would feel better if I had more help, or a stronger team.”
The truth is, there is no way to arrive at a well-thought-out result by considering all the relevant issues at the same time. This leads to flip-flop decision making because the different questions often lead to contradictory conclusions. Add to that the fact that the issue can be fairly emotional. Founders often feel as though they are selling their baby and /or that their self-worth is tied to the company. Alternatively, bringing in an investment partner when you have been on your own for years can seem traumatic at first blush.
From my experience, the solution to the problem is to not come up with one answer but to look at three independent components separately: market, financials, and personal issues.
Market: High-growth companies tend to go through an S-shaped curve of market development over time as markets move from early adopters to mainstream and ultimately mature buyers. Important variables include where you are in the market development and what your market share is relative to others’. Faster growth leads to higher value, so how you see your growth rate changing is a key driver to determining timing. Market share is also critical, so founders need to make sure they have the resources to maintain or increase market share as market growth accelerates. One of the biggest destroyers of value for bootstrapped founders is that, after pioneering a lead position for a new technology product or service in an early-adopter market, they then cannot keep up with market growth because of insufficient capital, and so they lose market share. Lost market share means lost potential share value.
Financials: Look at a three- to five-year forecast and discount the cash flows back to today. Focus on the risks with achieving the plan and reflect that in how much you discount the future revenues. Compare the value of a sale today versus a sale later. For high-growth companies this analysis almost always suggests a later sale. What resources do you need to achieve the rapid growth you forecast? What investments in the team, both management and the board, are necessary? How much risk is in the future plan?
Personal: Is this your first entrepreneurial venture? How diversified is your personal balance sheet? With many founders, most of their net worth is in their company. It is difficult to try to grow a company at the pace required to maintain market share when your entire net worth is at risk. What are your risk profile and financial goals? Are you sufficiently diversified? For many entrepreneurs, selling some of their shares to an investor is a good way to reduce their risk while also growing the company as fast as the market requires. After assessing each of these areas, step back and see if all the components point to the same decision. If so, your decision is easy. If not, focus on the issues that are out of line and look for solutions to those. Perhaps the market assessment suggests not selling the company, but the personal analysis suggests risk diversification and more experienced support to help you achieve your forecast. If that is the case, then a partial share sale to an experienced investor could be a good solution and could help you achieve a bigger future outcome.