Optionality and the Conversations You Need to Have

No entrepreneur wants to sell their company. No investor can stay invested forever. Everyone knows this. Yet, honest conversations about the next steps often occur too late. In the current environment, founders should prepare for several outcomes, and investors should be there to support them along the journey. 

I’ve long been an optionality enthusiast. For me, optionality requires laying the groundwork, building trust, and continuous open communication with current and potential stakeholders; it’s energy worth spending to stay in the driver’s seat, ride out the next 12 months, and land well-positioned when capital flows back in.

For the past two years, we’ve seen startups stretch their dollars, cut jobs and revise their roadmap as funding dried up. The bulk of VC money went to portfolio companies performing well rather than emerging ones. We expect a change of pace this year, with more M&A, private equity rollups, and downward pressure on valuations. That doesn’t mean investors should force founders to put their companies up for sale, but there is a risk it will happen nonetheless if they don’t anticipate the next steps. 

Exits Take Many Shapes

In 2023, Inovia’s portfolio companies significantly impacted the Canadian tech software sector, with three notable exits accounting for nearly half of the sector’s total exit value distributions. Poka was acquired by IFS, Granify was acquired by Bazzarvoice and Clearpath Robotics was sold to Rockwell Automation. This high concentration can be attributed to the limited focus of investors on manufacturing exits. Many tend to adopt a passive approach, often waiting for acquisition opportunities to arise. In contrast, over the last decade, our team at Inovia proactively engaged with founders from the early stages so they could create options, compare them, and make the decision they were most comfortable with along the way.

I believe an exit can take different shapes. Sometimes, selling is the best growth avenue for founders: they may become the lead acquirer in a private equity-led roll-up strategy or continue expanding as a separate entity under a larger group. 

Other times, refreshing the cap table for further growth over the next decade is the best path forward. That’s why we helped buy out earlier investors in AlayaCare and Lightspeed. That’s also why we created a continuation fund in 2021, to support further growth of a handful of high-performing portfolio companies from older funds and bridge the gap between the time horizon of those funds and the time horizon of building global companies.

Poka is another great example of optionality. It had lots of money in the bank, several suitors, and was in a position to raise growth capital. Two years before their acquisition, we started the conversation with Founder and CEO Alexandre Leclerc and his co-founder Antoine Bisson. Then, we accompanied them every step of the way, ensuring they understood the nuances of each option. In the end, they chose the one they believed was the best for their employees, their investors, and their company.

Over the last two decades, I’ve come to realize that for all our best exits, we have sat down and worked with the founders, shared our needs, and listened to their aspirations. That’s what sets entrepreneurs up for success. 

Shake Off the Old Mindsets

Unfortunately, this approach is the exception. The idea of “letting your winners ride” is still going strong in the VC industry, even though we all know there is a time limit to a fund, usually pegged with a ten-year term.

So, how do we shake off those habits and still optimize returns? Work is required on both sides to manufacture an exit. Founders need to map their ecosystem, build strategic relationships, and manage the expectations of potential investors, current investors, and potential acquirers. Lining up potential acquirers doesn’t mean a sale is imminent. Still, it may help companies fundraise when investors feel there is optionality for an exit in the future, and it may help set a higher valuation bar.  

Investor fatigue exists. Founders should revisit their cap table regularly to see which investors may need or want to be bought out. A strong board and a clean cap table allow founders to stay in the driver’s seat. Founders also need to understand the market they’re operating in, which means accepting that valuations fluctuate with market conditions as much as with company performance. 

Investors, for their part, need to be transparent with the management team on their divestment plans and work on monetization events that won’t hurt the company. Selling a minority stake in a secondary transaction takes time and diplomacy with all stakeholders, including managing other investors who may be tempted to piggyback on a specific stakeholder exit. 

While these conversations won’t be easy, they are some of the conversations that should take place way ahead of time. It’s not just about go, go, go, build, build, build, create value, increase your valuation! Investing is important, but divesting is just as important. And it’s more complex to manage.

More on Optionality

Don’t miss the insightful discussion between Chris and Ilan Saks on the Unstacked Startups podcast. They delve into the importance of ‘optionality’, AI’s impact on business, and the strategic role of talent and culture in building successful companies.