Startup Exit Strategies: Are PE and EBITDA the New Black?
Should an entrepreneur consider engaging with the world of VC, they need to include an exit strategy in the early days of their startup. Remember, the type of company, including its market, that you want to create will ultimately shape your exit strategy. While venture capital can be a viable option, it’s far from the only one. In this paper, we’ll explore what it truly means to accept funding from a venture capital firm and how to prepare for the exit ahead.
Bringing a venture capitalist on board can sometimes feel like a dream come true for entrepreneurs. However, if you’re banking on selling your company in 2–3 years for a massive payday, you might want to reconsider. The truth is, venture capitalists are not just investors; they’re partners with a focus on high returns, typically within 7–10 years. They want to see substantial growth and a significant exit — something that rarely happens in just a couple of years.
VCs represent their investors, known as Limited Partners, who expect a solid return on their investment within 10–12 years on the entire fund’s portfolio, not just one company. This means the fund is under pressure to deliver strong financial performance. VCs must work on creating the best compromise between value creation and exit probability, whereby the optimal point is rarely in the first 2–3 years post-VC investment. There are always exceptions to this long-term approach, be it a fantastic asset being acquired early or reconsidering the exit timeline for a struggling company, sometimes it can be more strategic to pivot towards more modest early liquidity. When considering value creation, this general long-term mindset is key even when looking at shorter-term defensive and offensive exit routes. If you’re interested in learning more about how funds define and measure performance, check out this article where we share the performance of our first fund here.
Since the financial performance of a fund is a multiplier, the size of the fund matters. Their strategy hinges on backing businesses that not only promise growth but also showcase solid financial performance. It’s all about hitting those goals to meet the ambitious expectations of deep-pocketed investors.
In recent years, IPO held the title for the dream exit route although the most likely exit route remained strategic M&A. As the market has evolved, a new important player in this strategy has emerged over the past five years: private equity. So, what does this mean for an entrepreneur’s exit strategy?
Navigating the private equity route is a transformative opportunity for both entrepreneurs and investors, and it’s crucial to understand its intricacies. According to a 2023 Clipperton report, for European software businesses valued over €30M, PE funds accounted for 80% of all exits in 2022, signalling a significant strategy change. From Elaia’s perspective, we have noticed this recently with several of our portfolio companies, including Zenchef and PSG, iBanFirst and Marlin, Mirakl and Permira, Shift Technology and Advent working hand in hand. For these four companies, we backed the early days and have seen them grow and develop into PE-backed businesses.
Examples of theintersection of PE and Elaia’s portfolio
While IPO (strong financials) and strategic M&A (value of tech assets) have their own criteria for qualification, private equity is seeking high, profitable and sustainable growth. If a PE exit could be the right fit, this means considering aligning your growth trajectory with PE expectations that can unlock lucrative exit opportunities. To be a legitimate candidate for the PE exit route, you need to drive your company towards profitability.
However, beware — private equity isn’t a fit for every business. If your company isn’t EBITDA positive or lacks a solid growth story, this exit door may slam shut. The PE game takes other considerations into account, such as the potential for consolidation strategy to build a market leader.
Once considered to be a more traditional business valuation tool, EBITDA has re-emerged as a primary factor for evaluating startup performance. This means that a startup that focuses on its EBITDA can open the full spectrum of profitable exit options.
The evolution of the market and the rise of PE is reminding us that EBITDA (the principle key to measure the performance of companies) has now become an important way to measure the business of startups. While other value creation approaches exist (e.g. hyper growth or tech IP), EBITDA is now (due to market correction) back in style.
Being EBITDA positive not only enhances your company’s appeal to buyers and makes you PE-friendly, but also demonstrates operational efficiency and sustainable growth. Whether you’re eyeing a venture capital exit, a private equity acquisition, or even an IPO, financial health is a key to unlocking these lucrative opportunities. If you want to maximise your exit potential, prioritise profitability — because in the world of exits, cash flow is king!
Navigating the complex landscape of exits requires a keen understanding of the various dynamics at play. The VC mindset on exits emphasises the need for rapid growth and high returns, but it’s essential to prepare for a meaningful exit that aligns with both your vision and your investors’ expectations.
As the landscape shifts toward Private Equity, entrepreneurs have a new avenue to explore, one that prioritises stability and profitability. Ultimately, achieving positive EBITDA not only enhances your company’s attractiveness to potential buyers but also positions you for success in both VC and PE environments. By understanding these elements and strategically aligning your goals, you can pave the way for a successful exit that maximises your company’s potential and secures your entrepreneurial legacy.