Family Offices and Venture funds create studios to improve ROI. However, setting a fixed process for growing portfolio companies can slow growth or miss opportunities to improve exit multiples. This article looks at how to recognize a bad or mis-matched process, and use consultative relationships to improve our chances of a great exit.
Defining “Exit”
Today we’re talking about an early stage investor’s exit. Pre-Seed through Series A investors generally try to reduce or realize their investment when the startup hits Series B. They usually do that by selling their interest to a larger fund. The amount they earn from their investment, the carried interest, is generally expressed as a multiple of their initial investment. For example, an investor who invested $10,000 and is paid $30,000 for their shares had a 3X return.
Whether or not that’s a good return depends on how long you had to wait to get the return. If you were able to cash out after two years – that‘s a good return, if you have to wait ten years, maybe not. So early investors have an incentive to accelerate their invested deals to the fund’s exit series.
Obvious ≠ Easy
Obviously getting your invested deal to your exit point faster improves your returns and obviously an invested deal with better financials improves your returns – but how do you pull these levers?
If you are a FAMO or VC you may staff a studio with experienced Executives in Residence (XIRs) then ask them to accelerate their assigned deals. You may also ask the XIRs to use a standard, milestone-based process to help you measure exit readiness. On paper this sounds great and in practice it sometimes works – but often it actually slows down deals. Let’s look at these fails in more detail:
1. The studio mandates the same process for every deal in the studio. This gives you a sense of control but often results in growth delays as founders and XIRs perform tasks and complete reports that really don’t apply to their startup. Meanwhile, new steps or activities that would accelerate the deal are skipped because they aren’t part of the mandated process.
2. The XIR applies a process from the wrong domain. Most XIRs spend their careers in one or two verticals, finance, healthcare, or consumer goods, for example. Unless you are very selective about your investments, the startups assigned to an XIR can quickly drift away from that person’s expertise. However, the XIR may continue to use the process that worked for their previous vertical – which either wastes time or skips steps.
3. XIRs are responsible for too many deals. When an XIR is stretched across several deals, the XIR will naturally try to standardize their process for getting their deals to exit. Even within the same industry vertical, deals may need very different approaches so “rinse and repeat” fails to achieve the expected exit multiple.
4. XIRs rely on LPs for help. Not only does every LP try to apply their own process, there’s a power mis-match inherent in the relationship that ties the XIRs hands. The XIR may see the LP's process is slowing the startup down but be powerless to intervene since the fund is worried about losing future investments from the LP and his/her network, if the XIR is perceived as rude.
The solution is professionalizing the XIR’s network – adding an outsourced studio service that easily blends into, augments, and influences the XIR’s process. There are several benefits to a retainer-based relationship with outsourced studio:
1. Cohesive team – agreeing upon and using the same processes.
2. Speed – drawing on a large talent pool with diversity of industry and experience to quickly provide talent while the engagement manager onboards each person into their role and the process the team is using with the deal.
3. Ongoing relationship – the outsourced provider helps the XIR look ahead to needs several weeks out and prepares support in advance, the engagement manager becomes a trusted advisor to the XIR.
4. Best practices – when the in-house XIR knows the process needs adjustment, they can turn to their outsourced partner for help.
5. The XIR controls the relationship – because they have authority over the outsourced service provider (unlike the XIRs relationship with LPs.)
Conclusion
Every deal is different and should be taken to exit using a customized process for company growth and leadership development. XIRs trying to do this alone often lack the experience and resources they need to succeed. Using an outsourced studio service supports the XIR while leaving them in control.
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