What is a startup exit? Why are exits considered the measure of success? How do you tell whether an exit is good or not?
An exit from a startup is the sale of equity to a strategic buyer.
- Kinopoisk operated independently; the shareholders sold their stakes to Yandex for $80M and made an exit.
- My fund AddVenture II owned a stake in the gaming company Pixonic and sold it to Mail.ru Group (with a 16x cash-on-cash return), making an exit.
Why is an exit the measure of success?
- Because it's hard. And extremely rare.
- In markets like the Russian one, there are very few strategic acquirers, and IPOs offer no liquidity. I described the problem in more detail here.
- Because venture industry is fueled by capital from VC funds and angel investors, and they expect a return on their money. By the rules of the game from the very start, everyone is heading toward selling the business — that's our "catching the snitch" moment.
A caveat: I consider my main achievement not the 6 exits (4 of them above $15M and 2 with 3x cash-on-cash), but rather 11 startups with revenue above $1M (the largest two — $120M and $200M+ during my time, and around $1B after I left).
Why? It's even harder. Building a money-making machine a) practically without investment, b) across 11 different markets (from gaming and e-commerce to advertising and online education).
11 times — that's confirmation of a system, not luck. Clearly, it will work the 12th and 13th time too.
Why do founders sell their startups?
- Suppose a project earned 10 conditional units of profit last year. A buyer comes along and offers to buy the business for 100 units. The business may grow, or there may be a COVID or another black swan. Essentially the offer says: "take your dividends for the next 10 years and go do something new."
- Most often, by personality type, founders love new things. I was climbing the walls in my 12th year at Eduson. Even though the business model changed several times (online MBA => B2B in Russia => B2B in the US, and only in the vertical of sales teams' training => a series of experiments with B2C products (Testla, Ginger, etc.) => and finally the one that took off, Academy). Each time it was a new business — new IT solution, new content, new audience, new team. Even so, sitting in a single industry was boring as F for me.
- Sometimes further growth requires major investment in infrastructure or marketing (or you need a ready customer base). The YouTube team couldn't pay for the servers, was forced to sell to Google and, swallowing their suffering, took the unfortunate $1.65B.
- Other reasons: a) too good an offer, because the buyer is paying a strategic premium; b) the business has outgrown the founder, and competence is insufficient; c) growth has slowed; d) pressure from investors (who have their own fund timelines); e) fire sale — selling a failing business as if there's a fire, for the customer base; f) the founder burned out and\or saw a more interesting idea; g) conflicts inside the team and so on.
Why do strategics buy startups?
- Strategic reasons. Groupon was heading toward IPO. They needed Russia and Japan to call themselves a "global leader." The IPO date and the date of the last announcement before the "quiet period" were strictly fixed. The deadline pressed on every party. That's why signing the documents took only 3 weeks (including due diligence by a Big Four firm). I was naive to believe this was how it normally worked.
- A premium to valuation. If a public company trades on the stock market at, say, 5x revenue, and a startup is bought at 3x, then its market cap rises disproportionately, the Board of Directors is happy, and spirits are high.
- Speed. Buying growth is faster than building. The startup has already found product-market fit. Corporations find it cheaper and faster to buy something ready than to spend 2–4 years on internal R&D. Not to mention their two left hands. For example, Headhunter spent many years trying to launch an online education service while sitting on a goldmine of targeted traffic. I'm still waiting.
- Capturing market share and customers. An acquisition gives instant access to a user base, contracts, sales channels, and brand recognition.
- Killing a competitor. Sometimes a startup isn't needed as an asset — it's needed as a threat that has to be neutralized before it's too late. By that logic, Facebook bought Instagram — the ends justify the means.
- Access to technology or IP (algorithms, patents, data, content). When Netflix planned to buy Warner Bros. (the deal was later canceled), they were after the rights to the movies.
- And the scariest one — synergies with current products. Almost never works the way it was planned. The goal is for the startup to strengthen the core business: increase LTV, reduce churn, add upsell, complement the product line.
How do you evaluate an exit from the outside?
It's hard to do without seeing the documents (Share Purchase Agreement, cap table). Too often:
a) different shareholder groups are bought out at different valuations;
b) part of the price is tied to KPIs;
c) often the payment is at least partly in equity — locked up for a long time, and the stock price is volatile;
d) and to make sure life doesn't feel too sweet, exhausted founders are often kept on for 2–4 years to vest their shares.
In the (almost documentary) series Silicon Valley, those are the people who sat on the roof drinking beer and waiting for the end of the vesting.
But there are a few observations\heuristics that help you assess an exit without SPA:
- If the total amount raised was, say, $10M, and the company was bought for $15–20M, then almost certainly 100% went to the investors (because of Liquidation Preference), and the founder is left to lecture about "successful success" at Berkeley. Rule of thumb: if the multiple is below 2, the founders are out of luck. Above 3–5, the founders are in chocolate.
- Similarly, if the last round's (post-money) valuation is below the exit. For example, $6M raised at $30 (i.e. $36M post-money) and sold for $25M. There was definitely heavy dilution in favor of the investors.
- Look at the number of rounds. The more there are, the worse, because of dilution. 2–3 — OK, there's a chance for a good exit. More than 5 — unlikely.
- Usually, unsuccessful deals are quiet.
- Founders themselves start investing, especially as LPs in funds — a good signal, but not fast and not public.
- A startup acquired (outside of AI) with a team under 30 people is almost certainly an acquihire (the investors got 30–60 cents on the dollar, the team got "bread and butter," and were promised a bit of caviar).
- Where are the founders? After the MSQRD acquisition, the founders moved to work at Facebook's London office. That means there was vesting in the deal and they had to wait it out. There's no other reason to suffer in a corporate role. This fact says nothing about the size of the deal — only about the timeline.
What I'd recommend
- Hire strong M&A advisors with experience in your vertical. Check their references.
- Hire lawyers specializing in M&A deals' documentation.
- If you have experienced angels among your investors, make active use of their network of contacts.
These 3 points solve 95% of the problems.
Good luck!