An Exit Strategy Mindset – A Case Study On Choosing “Good” Vs “Bad” New Business Ventures

Introduction

The crafting of an exit strategy for a business and the harvesting thereof is the ultimate measure of success for entrepreneurs. This process starts when entrepreneurs choose new ventures (to build or to start from scratch). These decisions can either be good or bad as far as harvesting potential are concerned.

Over more than a decade Ventex Corporation advised and assisted companies with their exit strategies. This case study highlights various “good” vs. “bad” ventures in this regard that we consulted to. Contrasting companies are discussed under some of the key aspects of choosing the right venture with an exit strategy mindset. These key aspects are:

  1. The window of opportunity.
  2. Match of entrepreneurs’ profile with opportunity.
  3. The economics of the business.
  4. Competitive edge achieved.
  5. Harvesting dynamics.

The Window of Opportunity

The timing of an exit strategy needs to be carefully planned. Ideally entrepreneurs should embark on new ventures when a window of opportunity starts to open up and harvest it when the window of opportunity is still wide open. The IT industry and specific the dot.com bubble that burst is well-known in this regard.

Two of our clients in the cellular industry are excellent contrasting examples of timing. Cellular Good embarked on a specific niche area in the pre-paid voucher market just when the window of opportunity started to open up. The company quickly grew into quite a force and was bought within 18 months for a price-to-earnings ratio of 12 based on its serial income and projected growth.

Cellular Bad embarked on the similar niche area, but only a while after Cellular Good was sold. The company grew reasonably fast, but when they want to harvest the window of opportunity was closing down rapidly. Finally they sold the company for only the net asset value to a major player (who basically bought the client list to whom they want to sell other products).

Match of Entrepreneurs’ Profile with Opportunity

Entrepreneurs need to ensure not only that a real opportunity exists, but also that there is a fit between their profile and the opportunity. They need to have the right attitude, skills and risk profile to match the requirements of the opportunities.

Two of our clients in the service station industry (fuel and food court) highlight the fact that passion for an industry and commitment to it are vital for the success of the business. Station Bad bought a business in a residential area when the area was booming. The entrepreneurs did very well in the beginning, but soon lost interest and turnover declined drastically. They finally sold the business after four years to Station Good for a small profit.

The entrepreneurs in Station Good had a real passion for the industry and they put all their energy into the business. The business grew tremendously and after 30 months they sold it for more than twice the purchase price.

The Economics of the Business

Sound economics are crucial for any new venture. This includes factors such as size, profit margins, break-even points, capital requirements and return on investment. Entrepreneurs need to carefully analyze any new venture in this regard. If the economics are not sound the business has a small chance of surviving and even less chance of being harvested.

Two of our clients embarked on ventures in similar industries (agro-related), but with different niche markets. Agro Bad started a new venture in a crowded market and could only achieve an average gross profit of 18{5c84b89e0cba74b6d8cdc777bf9a8338d14dd91243071983e74bc62a6792d410}. Due to the intensity of competition their cost of doing business was very high and they only achieved a net profit of 1.5{5c84b89e0cba74b6d8cdc777bf9a8338d14dd91243071983e74bc62a6792d410}.Agro Good was established in a much less crowded market. The company did their business without making too much waves. Their gross profit margins were close to 28{5c84b89e0cba74b6d8cdc777bf9a8338d14dd91243071983e74bc62a6792d410} with a net margin that averaged out at 14{5c84b89e0cba74b6d8cdc777bf9a8338d14dd91243071983e74bc62a6792d410}. This company is currently worth more than ten times as much as Company Bad (with similar turnovers) and it is also easier to harvest.

Competitive Edge Achieved

Entrepreneurs need to ensure that they can achieve a competitive edge in any new venture if they want to make money and have an exit strategy in mind. This can for instance be achieved through proprietary products, know-how, economies of scale, relationships and systems.

Two of our clients in the IT industry brought different offerings to their clientele. IT Good had specialised knowledge on computer networks and sole distribution rights for specific products in the geographic area where they operated. They grew their profits at 37{5c84b89e0cba74b6d8cdc777bf9a8338d14dd91243071983e74bc62a6792d410} cumulative per year over the last seven years and became a major player in the region and are currently in high demand by international companies.

IT Bad started out the same time, but except for good service and the right to sell certain products (not exclusively) they had no competitive edge. They grew their profits at a good 11{5c84b89e0cba74b6d8cdc777bf9a8338d14dd91243071983e74bc62a6792d410} per year cumulatively over the last seven years. Seven years ago both companies were about the same size. The turnover of IT Good today is more than four times that of IT Bad and the value of the company is about eight times that of IT Bad.

Harvesting Dynamics

The integral dynamics of a business and its industry should be sound for good harvesting potential to exist. The trends in the industry, the type of business, the sustainability of the profits and the cashflows are some of the aspects that need to be considered by the entrepreneurs.

Two of our clients in the training industry show the importance of separating the entrepreneur from the business. Training Bad is in business for 15 years. They provide customized training for multi-nationals. They are well-sought after in this market but they basically work from contract to contract. The company tried to sell shares and also tried to bring an equity partner in, but without any success. The reason for this is that the would-be investors feel that the company is to closely linked to the owners (aging) and their knowledge.Training Good is in business for 12 years. They also sell customized training, but in addition to it they have many well-packaged training courses that are presented under license by many facilitators. This company has several outside shareholders that bought into the company. A major listed company recently also bought a substantial equity stake in the company.

Summary

Many people see entrepreneurs, that are successful in harvesting their business, as lucky. Although luck can play a small part in it, the major ingredients are the necessary resources (e.g. capital and people), detailed planning, proper execution and hard work.

To enhance the chance of a successful exit strategy entrepreneurs need to analyze and choose a new venture with the utmost care.

Copyright© 2008 – Wim Venter