11 insights on Startup Exits

Welcome to a special edition of Exit Strategy, in collaboration with two business content powerhouses, Lucas Abreu from Sunday Drops and Luiz Silva Néto from Exit in Public.

---

A common frustration in the founder's journey is the moment when he will sell the company. After going through a few rounds of investment in which the way to be evaluated is through high revenue multiples, the moment he arrives to negotiate with a buyer, he discovers that the game is different.  

With a few exceptions, conversations during slower markets (which is normal in Brazil) rarely exceed a multiple of 5-6x revenue. It's a shock. Another problem is that most people are not prepared for this, after all they already have to deal with 1,000 variables in the complex system that is managing and growing a company. 

So it is. Seeing this problem, we got together to write/record content with a dump of very direct insights into M&As that founders need to know. 

This article reproduces the ideas discussed in the podcast: Tudo Sobre Exits, launched today on Abreu Podcast (only in Portuguese).  

Link: Spotify

Youtube: https://www.youtube.com/watch?v=n1movGQOQqg

Apple:

 

Insights: 

1 - Even the best companies are sold and not just bought  

Despite the common sense that the best companies are bought and not sold, we see that part of being bought involves wanting to be sold.

And wanting to be sold involves creating optional exit routes for your company. Being intentional in this process helps you get bought.

We will dive deeper into this contradictory truth in the next insights. But we leave the invitation for reflection ‘be rich or be king?’ which helps in the search for understanding what success means for you as an entrepreneur. 

2- The founder creates a company in search of freedom, but finds himself trapped when he has no alternative exit

After years focused on construction, the entrepreneur feels that the company that was a vessel for autonomy now bears the weight of responsibility for multiple customers, employees and investors. The founder does not see himself authorized to leave the company, even if it is doing poorly and if day-to-day life has become boring. Thinking about selling at this time is natural. At the same time, this is the worst time for it, after all it is too late.

When the founder keeps the dream of building something great but is grounded in also creating exit opportunities along the journey, he has a choice. When these opportunities materialize, he can choose whether to continue building if he is confident in this path or seek other proposals to choose the best of them.

In both cases, this strategy maintains the feeling of autonomy and avoids the feeling of imprisonment that the entrepreneurial journey can bring after a few years. The exit strategy is the path to maintaining freedom.

3 - The Lake Wobegon effect on Startup M&A

Most people believe that they are above average in terms of intelligence, sense of humor, appearance, skills and so on. This trend actually has a name, the so-called effect of Lake Wobegon. 

When it comes to Startup M&A, believing that it is above average is very common. It is very difficult for entrepreneurs to consider the scenario in which their startup, among several acquired from the same buyer or within the same sector, will have the lowest price, lowest multiple and/or will not have the best possible conditions.

This optimism in what is being built is a fundamental characteristic of entrepreneurs. But attention is needed because this often becomes an illusion. 

4 - Creating competition is the way to extract the best deal from an M&A

When a proposal is received, it opens the possibility of searching for others and choosing the best one. Conducted skillfully, this process can increase the value offered by the company. The first acquisition deal of Nubank, Plataformatec is a good example of this. The company was approached by a competitor, with a merger proposal (share exchange). Since it considered acquiring the consulting business, this proposal took into account the company's revenue and margin, but it was not the founders' dream exit.

They then used this trigger to raise the interest of some of their customers. Nubank was interested and needed to make a competitive proposal, even though it was an acqui-hire, for which revenue is not an important factor. In the end, the company was acquired by the Bank, under the conditions that the founders desired, but the deal only happened because another offer was used to create a competitive process. 

5 - The basis of exits in Brazil are deals below R$100 million 

Analyzing the biggest buyers of startups in Latin America: Magazine Luiza, Linx, Locaweb, iFood, B2W / Lojas Americanas, Méliuz, Mercado Livre VTEX, Accenture and Afya and keeping only those that are publicly traded Latin American companies, we compiled the transactions carried out for the period 2016-2021.

Through the financial statements made available, we see that 80% of the deals (n=88) had a price paid + earnout of less than R$100 million. Of the 20% above that, 11% are in the range of R$100 to 200 million reais and 9% in the range above R$200 million reais.

In a similar way, Benedict Evans brings interesting reflections on the M&A movements of Big Techs - Google, Apple, Facebook, Amazon and Microsoft - between the years 2010-2019.

Through the antitrust study conducted by the Federal Trade Commission on FAAMG, we see that 80% of deals (n=616) had a total price of less than $50 million. And 90% had less than 50 people on the team. 

6 - Preparing for an exit is a journey of building value for the company

Dubbed the MVP (Most Valuable Product) Journey by Fernando Taliberti, the value creation trajectory is a project that must begin well before an exit. To create fertile ground for competition when a proposal is received, as in the case of Plataformatec + Nubank, the founder needs to build a network of relationships that can be activated with a call (or even a Whatsapp message). This network must have more than one potential interested in acquiring the company, who can react quickly when they know that there is another proposal on the table.
But most buyers are slow and this decision flow can take a long time, unless the possibility has been considered for some time. How to sow this? Through this 5-step journey:

1. Thesis - Think about why a company would buy (or merge with) yours. It could be an acqui-hire, an expansion of the business or product portfolio or have other strategic drivers. Which ones make sense to put your company on target?

2. Companies - For each thesis, which companies could have these motivators. This chain of thought helps expand the horizon beyond the typical buyers who come to mind first. 

3. People - Within the company there are specific people who can sow seeds and convince the organization to carry out the business. Every business is done by people.

4. Relationships - Once people have been mapped, relationships must be built that bring them together and provoke the desire to purchase. These close relationships are the basis for starting a competition.

5. Competition - If the time is right to sell, a proposal received when seeding relationships can be used to provoke others and create competition.

Without preparing for this, either the founder will need to "put the company up for sale" when he thinks it's time (and it may be too late) or he may need to accept the only proposal he receives, as he will not have time to trigger others.

7 - A relationship can start as a business partnership and end as an M&A

When the thesis for an M&A is based on synergy through the union of two businesses, typically this thesis can be put to the test with a partnership. It's a great way to start reaping the rewards of the union, even without having to sell the company. For both sides, it can be an interesting test drive that reduces risks and proves the viability of the marriage.

The acquisition of Onyo (founded by Fernando Taliberti) by Alelo started with an integration partnership, which evolved into a white-label experience. Before acquisition talks even began, Alelo offered Onyo's product under the Pede Pronto brand. This experience helped reduce risks for both sides. The brand, technical feasibility, and relationship between the parties were put to the test, validating the sense of the transaction.

Although an experiment like this can fail and put the deal at risk, in practice, it anticipates something that could go wrong in the middle of the negotiation or even after it, which could be costly for both parties. It's worth putting everything to the test right away.

8 - How will you be evaluated in an M&A according to the company’s current situation  

The moment of exit is crucial to define how a company will be valued in an M&A, and this varies depending on the stage of development. Selling a company in the seed round or Series A, with revenues of R$500 thousand per month, is very different from selling a company with revenues of R$5 million or R$50 million. In early stages, buyer interest often focuses on team talent and product potential, with less focus on financial metrics like EV/revenue.

Morgan Housel has a quote that says: "the value of a company is the result of today's numbers multiplied by tomorrow's history". The earlier in the journey, the more the deal will be evaluated by history and less by potential. 

As the company progresses and reaches a revenue of R$5 million, it begins to play a more relevant role in the evaluation, but still without a decisive weight in EBITDA. Buyers' interest is more focused on business growth and scalability. When the company achieves revenue of R$50 million, the focus shifts to profitability, with EBITDA becoming a central factor in the evaluation, attracting a larger and more diverse pool of buyers.

Furthermore, the exit strategy must consider both external factors, such as market and economic conditions, as well as the company's internal dynamics, especially with regard to talent retention. It is essential to ensure that the transition is smooth and that the team remains aligned with post-acquisition objectives, whether to continue with the company or to integrate into a new environment.

9 - The possible trap in the earn-out model

Earn-out is a portion of the price paid for the acquisition of a company that is conditional on its performance after the transaction. It is often associated with revenue growth or other financial and operational indicators.

There is a potential misalignment of interests in the earn-out model, especially in cases where stronger product integration is necessary to reap the full synergies of an acquisition. Effective accounting for an earn-out based on the financial metrics of the acquired business (e.g., revenue, EBITDA) requires a degree of isolation that can reduce the potential for synergy generated. Consequently, achieving one's own goals may be compromised.

On the other hand, even if the metrics are not related to business operations and can be accounted for with strong integration (say, for example: the use of Leonardo AI features by Canva users), the integration may depend little on the founder and therefore their control over execution to achieve goals is limited.

These two scenarios make it important for entrepreneurs to be careful when negotiating earn-out clauses, especially in deals where they represent the majority of the value offered. 

10 - On average, technology companies have 7 to 9 years of life at the time of exit

How many times throughout your life as an entrepreneur will you be able to found, grow and sell a company?

On average, technology companies in Latin America take 7.7 to 9.5 years to be acquired. Considering that the entrepreneur sets up his first company at age 25 and sells his last one at age 65. Assuming the scenario in which all cycles actually culminate in an exit and not in the closure of the company, over these 40 years it would be possible to complete 4 to 5 cycles from foundation to exit.

The challenge facing this napkin calculation is: how many companies in this period will your company's potential buyers have purchased?

Segmenting this analysis between companies that received VC investment (n=189) and those that did not (n=365), we see that, on average, VC-backed exits are slightly faster than non-VC-backed ones.

Looking at the same study mentioned above regarding FAAMG acquisitions, we see that the median is in the range of 5 to 10 years at the time of acquisition. 

Another study that sheds light on the topic of time until acquisition is carried out by Ian Hathaway. In it, the metric is slightly different, as it analyzes the time from the first input to the output. Ian highlights that in 2018 the average was 6.3 years and the median was 5.4 years, and shows the increase in this time since the 2000s.

11 - Changing platforms as a lever for M&As

Platform switching is a driving force behind many mergers and acquisitions. When a new technology or paradigm emerges, established companies face the challenge of adapting quickly to avoid losing relevance in the market. A clear example of this was the transition to the cloud, where companies like TOTVS and Linx made strategic acquisitions to stay up to date and competitive. This same logic is applied to the current wave of artificial intelligence (AI), where industry giants are seeking to acquire specialized startups to dominate this new technological frontier. An example is the purchase of Hyperplane by Nubank.

This movement is deeply linked to the concept of the "innovator's dilemma". Consolidated companies recognize that disruptive innovation can come from anywhere, including small startups that start in a garage. To mitigate the risk of being outcompeted, they often choose to acquire these innovative startups, integrating their technologies and teams before they become a greater threat. Platform shifts, such as the transition to mobile or now to AI, are a powerful catalyst for this type of M&A, as they change the rules of the game and challenge companies to react quickly.

In recent years, we have seen companies becoming more sophisticated in their approaches to dealing with these changes. Initiatives such as corporate venture capital (CVC), building new businesses and strategic partnerships have become common tools in the arsenal of large corporations. This evolution shows that companies are learning to deal with innovation more proactively, using M&A not just as a reactive response, but as an integral part of their growth and adaptation strategy.

Finally, it is important to highlight how perspectives on innovation and M&A have changed over the last two decades. Today, CEOs and executives are pressured to demonstrate in quarterly presentations how they are approaching these innovations. Furthermore, preparation for IPOs and other forms of corporate expansion are also increasingly linked to a company's ability to integrate and benefit from these new technologies, ensuring its leadership position in an ever-changing market.

Conclusion

For the founder, thinking about exit is not normally part of everyday life. It's a distant event, which will happen if he works focused on building a great company. Being purchased is a consequence of a great product and excellent distribution. 

However, the insights shared in this article show a different reality. It is impossible for all startups to be above average, the time to exit is long, exit multiples and valuations are challenging compared to what is achieved on the VC track and things don't magically happen as a result of hard construction work.

It is necessary to look with care and attention at the journey of building not only the company, but the exit alternatives for the founder, his teams and investors. For all of them, this is the moment of great reward, even if they are not working on creating a company just to sell. Everyone, especially the founder, deserves a good exit as a reward for this journey. No one better than him to create the conditions for this.