There’s only 1 correct answer to what matters most to investors

What do investors care about most? Is it your vision? Your team? How you’ll disrupt an industry and change the world?

Nope. Those are all important parts of how you’ll be successful. But looking at the big picture, we’re investing to make money. And we only make money when the company completes “the exit.”

The exit is when the company is acquired by another company for cash (or public stock we can sell) or the stock becomes publicly tradable in an IPO. The exit is the event that that after many long years of waiting, the stock that we bought in your business is converted back into cash that we can use to pay for our retirement, send our kids to college, or re-invest in fresh startups.

Until the exit, our investment is dead money. Startup stock cannot be sold or traded. We cannot get our money back. It earns no interest. It’s nothing but a line on a spreadsheet that sits locked up for years. Even if the company valuation skyrockets on paper, there’s no way for investors to convert those paper gains into cash we can use to buy eggs and milk.

About 90% of our startup investments will fail to return our money. That 1 success out of 10 therefore needs to return 10x for us to break even.

But we don’t want to wait 10 years just to get our investment back. Given the high risk and lack of liquidity, we want our startup investments to beat investing in S&P 500 index funds or buying real estate. For successful venture investing, we need our winners to return 50x. (More on venture math.)

When we ask your exit strategy, we’re asking how you’re going to get a 50x return in 5–10 years. If your valuation is $20M now, how are you going to exit at $1B in a very short period of time?

There is only 1 correct answer.

The Only Exit for Venture Investments: Acquisition by a Strategic Buyer

For 99% of startups, the only exit that has the potential for a 50x return is an acquisition by a large public company.

Nobody other than a large public company can pay billions of dollars to acquire a startup. They will pay that much because your startup will open a lucrative new market for them or better position them against the competition. When it’s strategic, they’ll pay whatever it costs. A few billion dollars is a small investment in their future.

But while the correct answer to the exit strategy is simple — strategic acquisition — when I ask about your exit strategy, it’s the details I want to know:

  • what types of companies would pay a huge premium to acquire your business?
  • do those companies do frequent acquisitions?
  • what startups have they acquired in the past and how much did they pay (comps)?
  • what is the average acquisition price to revenues (P/R) for this sector?

The Occasionally Right Answer — IPO

The very largest exits are by IPO (initial public offering) that convert private, unsellable startup shares into public shares that can be bought and sold on the stock exchange.

IPOs are great. They offer the biggest returns. But they’re only for multi-billion dollar businesses.

If you’re planning to take over the worldwide hotel industry (AirBnB), taxi industry (Uber), rockets (SpaceX), payment processing (Block), generative AI (OpenAI), etc. your exit will be by IPO.

These current and former unicorns get all the attention, but they’re rare. Last year there were only 9 tech IPOs in the US. In 2023, there were only 6. In 2022, just 4, though during the pandemic bubble of 2023 when the bar for IPOs was low, there were 91. (Data from Crunchbase.) Pre-covid normalcy was 30–40 tech IPOs per year. (Full data here). That’s a miniscule fraction of the tens of thousands of startups founded every year.

If you’re planning to take over a very large industry and have a realistic plan to get to $1B in revenue within 10 years, an IPO is the right exit strategy. For everyone else, an exit strategy of IPO is absurd.

(There are small value IPOs such as the Toronto Stock Exchange or over the counter shares, but valuations are a tiny fraction of the NYSE or NASDAQ and don’t reach the required level of returns, so they don’t count as a successful exit.)

Wrong Answers!

I hear far too many early-stage pitches where the exit strategy is something other than strategic acquisition or IPO. That tells me that (1) the founders don’t understand investor requirements, and (2) it’s unlikely there’s a good way for investors to make a sufficient return from an investment their startup.

The following exit strategies are red flags that scream bad investment!

Acquisition by Private Equity = bad outcome

If you reach $20M in revenues and a few million in profits, private equity investors will be happy to snap up the business. Sounds great. Unfortunately, they don’t pay much.

PE typically pays 4–5x EBITDA, which usually works out to be around 1x revenues. (Sorry, we don’t believe those spreadsheets showing you reaching 60% profit margins. Reaching 25% would put you in world-class territory.)

Acquisitions by private equity are a common outcome for venture startups, but not a successful one. With PE acquisitions, we’re lucky to get our investment back, much less land that 50x return we’re shooting for.

Acquisition by Later Investors (secondary share offerings) = not how venture capital works

Many founders misunderstand how venture capital works. There’s an enduring myth that later investors will buy up the stock of early investors to get them off the cap table. Perhaps that happens in some countries. It doesn’t happen in the US venture world.

Later investors require their investment be put towards growing the business, not giving early investors a big payday. The simple rule for the venture world that keeps everyone’s incentives aligned is that nobody (founders, employees, early investors, later investors) gets anything until the exit where everyone gets a big payout.

Dividends = not how venture businesses are monetized

Traditional businesses focus on generating profits and paying out dividends to their owners. That’s a great plan for bootstrapped businesses, but doesn’t work for venture capital.

Venture funds have a fixed term, usually 10 years, after which the fund is shut down. All startups in the portfolio have to be monetized before then. An ongoing stream of dividends creates a mess.

Which rarely matters anyway since it’s exceptionally rare for startups to reach the level of profitability to pay out substantial dividends. If there’s extra cash, instead of paying dividends, investors want it put back into growing the business to reach a larger acquisition.

Management Buyout = doesn’t work for venture businesses

Traditional businesses often have multiple founding partners and sometimes a few outside investors. At some point, partners and investors who want to cash out can get bought out by the remaining partners for a few years worth of dividends.

Management buyouts do not generate the level of returns venture investors require and would never be the outcome of a successful venture investment.

Acquisition by Other Startups = not an exit

Founders sometimes tell me their plan is to be acquired by another startup. Sorry, that’s not an exit.

For big public companies where the stock can be bought and sold, mergers aren’t much different from acquisitions. But for private startups, the new combined entity is still private stock I can’t sell. The only thing that’s changed is moving my investment from a line in one startup’s cap table to a line in another startup’s cap table.

Pitching the Exit

A pitch to investors is not about how wonderful your product is. It’s a sales presentation where you’re selling stock in your business to potential investors.

Why should we buy that stock? Because we’ll make money.

How will we make money? It’s the exit, when the company is acquired by a big player in the space that is willing to pay a huge premium to add the startup to their business.

At that point, usually somewhere 5–10 years after we made the investment, our stock is turned back into cash, hopefully a lot more than when we started.

That’s the reason investors invest, so when you tell us we should buy stock in your business, we need to understand that there’s someone who would eventually buy the stock from us at a price that makes the investment lucrative.

Important Caveat

Some VCs don’t want to hear your exit strategy. They declare it a red flag that you’re even talking about exits at all. They’re typically looking at Series A stage startups, where the founders proposing dividends and secondary offerings have already been weeded out. Those VCs are often specialists in your industry and have been through multiple exits of your peers. You don’t need to tell them the comps and typical multiples in your sector — they know that information better than you.

There are also a few early-stage VCs that want to hear about your world-changing vision that will generate billions in revenues when you succeed. If you’re shooting to take over an entire industry, the exit is understood to be IPO, so there’s no need for discussion.

But for early-stage investors like me — individuals, angel groups, micro-VC funds — most of the companies we’re meeting are down to earth, building valuable improvements. They won’t get to tens of billions in revenue; our biggest worry is whether they’ll even reach $50M where an attractive exit starts to become possible.

We don’t know your industry. So we need you to show us that there strategic acquirers who would buy the company at an attractive valuation. We need to see that information in the pitch deck to evaluate the investment opportunity.

As always, know your audience and adjust accordingly.

Katie Deauville is the founder of the teleportation startup, SüprDüpr. She could’ve used some good advice on how to build a startup instead of following Elizabeth Holmes and the Theranos model. Find out what happens in To Kill a Unicorn, the most fun you’ll ever have reading about Silicon Valley.