An exit strategy is a plan that outlines how a business owner or investor will eventually sell their ownership in a company and realize a return on their investment. It's crucial for any startup, but especially for those working with the government, as this sector has unique challenges and regulations that impact how an exit can be achieved.
They include:
- The government contracting landscape is unique. Startups working with the government face different regulations, acquisition processes, and investor expectations compared to purely commercial businesses. Ignoring these unique aspects can limit exit options and potential returns.
- Understanding the government's role is essential. Government-focused startups often work with sensitive technologies or operate in strategically important sectors. This means the government may have a say in the startup's exit, requiring careful navigation and stakeholder engagement.
- Valuation and profitability considerations are key. Defense industry valuations, for instance, prioritize consistent cash flow and profitability over high revenue multiples. Startups need to align their financial strategies accordingly to attract potential acquirers.
In a panel discussion at BMNT Ventures’ recent Naval Private Capital Bootcamp, Chris Moran, executive director and GM of Lockheed Martin Ventures; Steve Weinstein, general partner of America’s Frontier Fund; and Jamie Tenedorio, a multi-time founder/CEO with nine exits, discussed how government-focused startups can proactively develop a well-defined exit strategy, and increase their likelihood of a successful and profitable exit. (Watch their full conversation here.)
The BMNT Ventures event, held in Palo Alto, CA, drew founders of deep tech, defense-focused companies, Silicon Valley investors and R&D government executives.
The panelists said that for deep-tech companies to work successfully with the government, they must have a keen understanding of the government landscape and how it differs from the commercial world; know how government contracting processes work; develop strategic relationships; and be able to anticipate due diligence hurdles. Here’s what they had to say:
Understand the Unique Landscape
The defense industry operates differently than the commercial world, significantly impacting valuations and exit strategies.
Recognize that defense primes base acquisition valuations on accretive cash flow, they said, and focus on generating consistent cash flow and achieving profitability to make your company a more attractive acquisition target.
As Moran emphasized, "The defense industry is not like the commercial business. You can't create a slick advertising campaign and create demand. The budget is fixed." This reality means that standard valuation metrics, such as high revenue multiples, often seen in the commercial tech sector, don't apply in the defense sector.
Navigate Government Regulations and Requirements
Government contracting involves unique regulations that add complexity to the exit process.
- ITAR Controls: Consider the implications of International Traffic in Arms Regulations (ITAR) on your technology. Splitting the company or establishing a separate federal systems division might be necessary to comply with ITAR and facilitate a smoother acquisition.
- Government Approval: Recognize that the government may have a say in your exit, particularly if you've received SBIR funding or if your technology is deemed strategically important. Engage with relevant government stakeholders early on to understand their perspective and potential concerns.
- Security Clearances: Factor in the complexities of transferring security clearances during an acquisition.
Engage legal experts specializing in government contracting to navigate these complexities and ensure compliance throughout the exit process.
Know Your Investors
Seek investors who understand the nuances of the government market and align with your long-term vision. Tenendorio, currently CEO of Med Tech Consulting Partners helping companies formulate commercialization strategies for government funded R&D, counseled founders to be "intentional" from the onset about what type of investor they need and keep this in mind as they look for and speak with potential investors. Not all investors are a fit and misalignment between an investor and the company is often a very difficult problem to deal with, he said.
Also key, according to the panelists:
- Alignment on Exit Strategy: Ensure your investors understand your desired exit timeline and are comfortable with the unique dynamics of the government contracting space.
- Industry Expertise: Prioritize investors with experience in the defense or government sectors. Their guidance and network can prove invaluable as you navigate the complexities of an exit.
"Be very aware of who your investors are, the quality of the investor, and where they are in that fund process," advised Tenedorio.
Build Relationships Early On
Develop strategic partnerships with potential acquirers well in advance of any exit plans.
- Foster Collaboration: Engage with the partnership teams of potential acquirers, showcasing your technology and demonstrating its value proposition.
- Network Strategically: Attend industry events and conferences, connecting with key decision-makers at potential acquirers.
Building strong relationships can position your company as a valuable asset and potentially lead to an acquisition initiated by the acquirer themselves, the panelists said.
Prepare for Due Diligence
Maintain meticulous records and address potential red flags early on to streamline the due diligence process.
- Organized Data Room: Establish a well-structured virtual data room containing all essential financial statements, legal documents, HR records, and intellectual property information.
- Preemptive Audits: Conduct internal financial and legal audits to identify and rectify any potential issues before engaging with potential acquirers.
- Open Source Software: If your technology relies on open source software, ensure its use is well-documented and compliant with licensing agreements.
Anticipating potential due diligence hurdles can expedite the acquisition process and prevent last-minute surprises.
Consider Alternative Exit Routes
While acquisitions are common, explore alternative exit options that align with your company's goals.
- Profitable Sustainability: If you don't require external capital, consider building a profitable, sustainable business within the government contracting ecosystem.
- Strategic Secondaries: Explore secondary offerings to provide early investors or founders with liquidity without necessarily pursuing a full acquisition.
“Just don't forget that it's okay to have a profitable, nice business that's growing or even stable," said Weinstein.
