Existential Decisions and Defensive Exits

Rogers’ poker metaphor applies to many of the tough life decisions we face. But heeding this wisdom is hard in practice; how does one know to take which action, and exactly when is when?

In an entrepreneurial context, these questions are especially challenging when they involve strategy pivots or defensive exits (i.e. the non-story book kind). This gets even more complex for a CEO who has raised outside capital. A translation of The Gambler into startup-speak might sound like:

A CEO has got to know when to continue growing

Know when a strategy isn’t working

Know when to conduct an orderly exit

And know when to salvage a fast-sinking ship 

Let’s take a look at each of these situations in detail to better understand how entrepreneurs and investors might respond. 

A CEO has got to know when to continue growing. Even when things are going according to plan, there are still decisions to be made about which levers to pull in the unending quest towards optimization. The timing of those “little” decisions can be guided by any number of factors both within and outside of the company’s control, but a CEO and her board generally have fun navigating this terrain. When inevitably the company hits a significant enough speed bump, the CEO will need to…

…know when a strategy isn’t working. When there is enough data to confirm that the speed bump is indeed significant – the workarounds have been explored, the different sales pitches have been exhausted, the replacement hire has proven ineffectual, etc. – a CEO will typically align with her board on a strategic shift. Unfortunately, CEOs (and boards!) often wait too long to make a decision like this because inertia holds them in place, sticking to the original plan and hoping for different results (after all, oftentimes a stubbornly singular focus allowed them to get here in the first place!). CEOs and boards should be constantly challenging each other when the company is not meeting plan to determine whether a big shift is needed. Ultimately adopting a new posture happens when the risk of charting a new, unknown path is clearly preferable to spinning wheels in place, which for a cash-burning startup is a death knell. But even well executed pivots can fail to take hold, and eventually the direction will need to change more concertedly toward exploring an exit. In other words, the CEO needs to…

…know when to conduct an orderly exit. One of the most challenging decisions a CEO will make, in league with their Board, will be when to sell, especially if the company has not yet achieved its lofty goals. Indeed, the exit that happens in most cases is not one with buyers clamoring at the gates with attractive offers, but rather when a company ceases to make meaningful forward progress and can’t raise more from investors to satisfy its cash burn. At this point the desire for some lesser (but tangible) financial return outweighs holding out for better days. Selling to a buyer or investor who is willing to take the company to the next level at a modest or cut-rate price is usually the solution.

Most equity investors start out with the lofty goal of a 10X+ return, in order to rationalize the very real risks of early stage investing. However, these same investors revise downward their expectations as the challenges mount. At some (low) point, even a 1X return of capital can be a form of success when a company has exhausted all options and simply ran out of potential. 2-3X returns are much more satisfying because at this level common shareholders (i.e. employees) are generally able to share in the modest spoils. 

What is not considered a success is when companies take too long to orchestrate their exit, bleeding capital and remaining value out of the business along the way (customers stop getting serviced and walk away, inventory ages, key partners cut ties, etc). In order to avoid this, companies should have acquirers identified prior to needing them and in most cases initiate a process early and in parallel with ongoing fundraising. If that process is not started with enough time to conduct proper due diligence and conditions deteriorate further, a CEO must…

…know when to salvage a fast-sinking ship. It is critical that CEOs and boards act to salvage value in a company before cash runs out and value goes to $0. This is not only the number one priority for a CEO and a fiduciary responsibility of boards, but more symbolically can allow for the company’s mission to live on, even if in a transmuted format with a new owner. It can be compelling to put off talks with buyers while hoping for an 11th-hour investor or a big contract to come through and there are countless high wire acts companies navigate in normal course, but a quick sale process at a discount to a vetted buyer should always be an option that is kept warm and available during these periods. If a company has less than six months of runway and does not have this lever to pull then boards should act quickly to help a CEO establish one. 

Like a very high stakes poker game, existential cash management decisions are extremely challenging and have wide implications for all stakeholders in a startup business. For a board, they offer an opportunity to provide a CEO with much needed support and guidance along a key phase of the journey. This is especially true when winning the game is no longer in reach and the goal shifts towards preserving a few chips to take home for another day.