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Welcome to the last installment in the “How To Startup” series and an often overlooked step when creating a business: exiting. In short, an exit strategy is exactly what it sounds like - a way out, sort of. I say sort of because frequently a sale of a company is just a new beginning, but more on that below. Startups usually seek an exit to generate investment returns for their investors and shareholders (usually including their employees), or sometimes to limit losses. It is important for founders to keep the possibility of an exit in the back of their minds at different stages of the business’ growth. Some startups are “big swings” where founders and their investors believe the idea and the team have the potential to turn the company into a multi-billion dollar public company. But many startups are smaller ideas where a smaller sale is a good outcome and is something always to be explored. It is important for founders to know which of these best describes their company.
As we’ve already learned in previous installments, the most successful entrepreneurs are the ones who plan ahead. So now that your company has traction and growth—or you’re a proactive entrepreneur who wants to get ahead—it’s time to think about an exit for the business.
Types of Exits
There are many different common exit strategies, but ultimately the one you choose will depend on your own business, personal and financial goals. I cover some of the pros and cons of each strategy below.
Failing, but “failing fast” and liquidating can sometimes be the best route to minimize losses for a business. You’ll likely find yourself in one of two scenarios when considering a liquidation: you’re already at the end of your rope - be it financially or otherwise - or you can see the end coming. If you’re fresh out of cash, evaluate how you can responsibly wind down the business for all parties involved - yourself, employees and investors. If you can tell early on that you don’t have product-market fit or traction and you still have cash left, plan to exit early and return money to investors. A great example of this is when Jeffrey Katzenberg returned $350M to investors instead of simply running Quibi until it was out of cash.
Sale or Acquisition
If you plan to sell your company (a.k.a. if it is getting acquired), you can receive payment from the acquirer in cash, stock or a combination of both. The acquirer can pay you cash for the company or you can exchange your stock in your company for shares of stock in the newly combined company. This will let you maintain being an active participant and shareholder as the company continues to grow. It’s not common in tech for acquisitions to involve both cash and stock. If you believe the company is poised to continue scaling, then definitely consider receiving stock as a part of the transaction. A famous example of this is when Facebook purchased Whatsapp for $4B in cash and $12B in Facebook shares in 2014, helping them grow into developing markets. The Facebook stock that Whatsapp shareholders received ended up being worth many multiples of the $12B which it was valued at during the time of the deal.
The amount a startup can sell for is determined by a few factors. Here are a couple of examples of how valuations are determined:
- If it’s a small company worth <$10M, it’s probably an acquihire (the process of acquiring a company primarily to recruit its employees). In this case, acquirers usually value the target based on how many engineers or product people are at the company.
- If it’s a deal worth <$100M, it’s usually priced more on strategic fit than real analysis such as what the target brings to the acquirer. This could be technology, a great team, a new business line they can build on, great potential of the merger, etc. For example, when I was CEO of Zillow we acquired 16 companies, most of which were in the $10M-$100M price range, and we always determined fair value by focusing on the overall level of strategic fit of the target more than evaluating the actual financial results of the target.
- If it’s a bigger deal with >$100M, the target’s financial results are usually benchmarked against other public comps and require real math to analyze. At deals of this size, advisors such as investment bankers usually participate in the deal and bring the analytical rigor and external perspective needed to evaluate the fairness of the deal for both sides.
Sometimes a sale is the end of the road for a company. But more often than not, it is just the beginning of the next chapter. For example, when Zillow acquired StreetEasy, the leading real estate portal in New York, we invested significant resources to grow the company after the acquisition. We added headcount, rebranded the company, invested in advertising and grew it substantially post-acquisition. Far from the sale being the end of the company, it was really just the beginning. Another example is Google’s acquisition of YouTube in 2006 for $1.65B of stock. At the time, YouTube was struggling with a myriad of legal and copyright infringement issues from content owners and was struggling to keep up with user demand. Under Google’s ownership, YouTube cleaned up its content copyright issues, invested tens of millions of dollars in technology to improve the service, and today YouTube is probably worth at least $100 billion under Google’s ownership and stewardship.
Initial Public Offerings (IPOs)
Traditional: Taking a company public is one of the ultimate goals for many founders, but it’s not exactly the finish line. In fact, it’s quite the opposite. For example, I named our IPO preparation at Zillow “Project Step” to emphasize to the team that it was just a “step” along the way towards building a great business.
In an Initial Public Offering, a company sells shares for the first time to public shareholders, and the stock is then traded on a stock exchange. This can be beneficial for a few reasons, such as being able to raise capital, get research reports written about the company and create liquidity for your investors so they can sell their stock. On the flip side, IPOs can be expensive (the fees are usually 5-7% of the amount raised) and come with a lot of uncertainty. One of the biggest challenges with this method is that the IPO window can be open or closed, and is dependent on things out of your control.
If you do pick this method, a piece of advice I often tell founders is to act and operate like a public company well before you actually are one. More on this and IPOs at a later date as I’ll probably do a separate piece on it.
SPAC Merger: A Special Purpose Acquisition Company (SPAC) is another way for a company to go public. With a SPAC, a publicly traded company is created for the purpose of acquiring or merging with an existing private company. One benefit of going the SPAC route is that, for now, company projections are permitted to be shared with investors during a SPAC merger which allows investors insight into a company’s growth prospects. I say “for now” because the SEC is evaluating this and there is speculation that it will no longer be permissible in the future. Another advantage is that you can select your shareholders through the Private Investment in Public Equity (PIPE) process plus receive advice and “sponsorship” from the SPAC itself which can be helpful to the company. The cons of a SPAC process are that it can be difficult to get enough investor focus on the company once you’ve gone public in this way, and SPACs are currently out of favor with investors.
Direct Listing: In a direct listing, a private company converts into being publicly traded but doesn’t actually sell any shares. Companies that choose to go public using this method usually have different goals than those that use an IPO - specifically, they do not need to raise capital through the offering. Direct listings create liquidity for existing shareholders and are usually less expensive than an IPO, but companies miss out on the chance to raise money.
Lessons On Exits
No matter what route you end up taking, when preparing for an exit: Always aim to be on the radar and top of mind for acquirers, understand your cap table and the goals of your shareholders, utilize investment banks and investors as resources and hire great M&A lawyers.
Missed a part or looking to reread? Part 1: Ideation, Part 2: Naming Your Business, Part 3: How To Pitch, Part 4: Surviving A Downturn, Part 5: Minimum Viable Product, Part 6: Product-Market Fit, Part 7: Scaling or read them all.
- When to Accept Startup Equity — and Why - dot.LA ›
- How To Brainstorm a Good Startup Idea. - dot.LA ›
To most people over 35, even those that consider themselves gaming gurus—the name FaZe Clan might be associated with mystery or even confusion. Is it an esports team owner? An influencer hype house? Or is FaZe Clan a merchandising company? Maybe it’s just a group of teenagers filming audacious “Fortnite” trickshots.
FaZe Clan CEO Lee Trink would probably tell you the Hollywood-based outfit is all of that, and then some. During a bombastic showing at NASDAQ headquarters where FaZe Clan rang the opening bell to mark its first day of trading as a public company, Trink proclaimed “now is the time for Gen Z to lead” the culture – while holding hands with FaZe content creators, of course.
Despite worming its way into the public consciousness relatively recently, FaZe Clan has been around for over a decade. Here’s a brief recap of the company’s origins, and their ambitions going forward as a publicly-traded gaming firm.
“The Voice of Youth Culture”
FaZe Clan’s start was simple enough – in 2010 three talented “Call of Duty: Modern Warfare 2” players linked up after meeting on Xbox Live to start a YouTube channel documenting their trickshots and antics in-game. Their first series was called “Illcams” and caught the attention of many teenage boys who wanted to both beat—and be—the players. Within two years the channel had a million subscribers and FaZe was competing in esports tournaments, laying the groundwork for what would become over 35 esports championship wins to date.
In 2014, FaZe bought a mini-mansion in New York and became one of the earlier entrants into the YouTube influencer house scene – though it has since upgraded to swankier digs in Los Angeles. Since then, the brand has grown its following to 500 million followers across social media, with 80% of that audience aged 13-34.
CEO Trink (a former Brooklyn Assistant District Attorney-turned-music executive who managed artists including Kid Rock) started leading the company in 2018. He oversees about 35 content creators and 15 pro esports players, plus the other 40-plus people on FaZe’s business side.
Lately, FaZe has expanded more into merchandising in an attempt to turn a profit. It recently sold $1 million worth of mouse pads designed by Japanese artist Takashi Murakami in one day and in recent months opened several pop-up shops.
“FaZe Clan will fund investments and we will create the product and we’ll own a bigger piece of the upside. That’s the future of the creator economy,” Trink told CNBC.
FaZe Clan CEO Lee TrinkCourtesy of Lee Trink
The Money Problem
Trink and the Clan clearly seem confident in FaZe’s potential. Wall Street doesn’t seem convinced just yet.
FaZe first announced plans to go public last year and said the deal could be worth $1 billion. But it's actually a $725 million SPAC merger, and the new entity FaZe Holdings Inc. was created by merging with a blank-check company set up by wealth management firm B. Riley.
It’s been a tough year for SPAC deals so far and most companies that sought a SPAC merger deal lost nearly half their value or more in the first six months of 2022 as investors wouldn’t stop selling. FaZe could rise above this trend, or become the latest to see its stock sink to new lows.
In its first day of trading, FaZe’s stock dipped 30%, trading at about $9 per share.
There’s clearly valuable brand potential in FaZe; Forbes estimated the outfit’s worth at $400 million. But it isn’t profitable just yet. In a 2021 report FaZe noted more than half its revenue came from sponsorships. and it made roughly $53 million last year – compared to $28.7 million in overall losses.
It remains to be seen whether FaZe Clan’s stock will sink or swim. After all, it’s unlikely most of the core Gen Z audience is trading its stock.The cash from the IPO deal could allow FaZe to invest more into content and direct-to-consumer merch, adding value and boosting its bottom line. FaZe will also look to buy out smaller firms in the future; Lee Trink told dot.LA last October that he is targeting acquisitions of content companies that could help FaZe break into streaming services like Netflix and HBO.
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Special purpose acquisition companies are having a real moment—and not in a good way.
In the last two years, SPACs have exploded in popularity as an alternative means of taking a company public. Los Angeles clean tech and electric vehicle companies, in particular, have embraced the model: Surf Air, Energy Vault, Faraday Future and Heliogen all spring to mind. But most of those firms are now trading well below their initial offering price—reflecting how a host of high-profile blow ups, combined with economic and regulatory forces, have turned the strategy into a financial pariah.
If you need a refresher, a SPAC is a means of taking a company public that circumvents many of the regulatory hurdles involved in a traditional IPO. The speed at which the process operates has made it popular in the tech sector, which loves to “move fast and break things.”
The SPAC model begins when a shell company (with no assets or business of its own, really) goes public through an IPO. Because the company is only a shell, the IPO process is extremely simplified with far fewer SEC hoops to jump through. Investors in the shell company typically receive stock at $10 per share as well as warrants, which are additional securities that allow them to purchase discounted stock in the future. The shell company then goes hunting for a promising startup that wants to go public; if they find one they like, they can then merge with that company, effectively folding the startup into the public company. Before the merger is complete, investors have the option to withdraw their investment or stay on the ride if they think that the target company will ultimately succeed.
Over the last two years, SPACs grew in popularity by an insane amount—with the U.S. SPAC market peaking at more than $155 billion in deal value in the first quarter of 2021 alone, according to a report from law firm White & Case. But since then, it’s been a downward spiral; U.S. SPAC deal volume cratered to less than $55 billion by the fourth quarter of last year, and slipped even further to around $8 billion in the first quarter of 2022, per the law firm’s report.
So why did the winds shift so suddenly? Most of the analysis points to three main causes.
The first is that SPACs aren’t performing well. While the stock market at large has certainly been bearish recently, the Defiance Next Gen SPAC Derived ETF (SPAK)—a fund that tracks a huge swath of SPAC performance—has declined around 30% since the start of the year, far outstripping the decline of the S&P 500 (which is down around 13% in that time). Add in a smattering of high-profile catastrophes likeNikola,View and—the granddaddy of them all—WeWork, and the space has started to look like a losing proposition to many investors.
Performance alone would be enough to slow SPAC enthusiasm, but the market is also facing heightened scrutiny from regulators. At the end of May,the SEC proposed tighter restrictions on the SPAC market that are designed to protect investors. The SPAC strategy has been accused by critics of offering outrageous value to the sponsors who initially form the shell companies, while offloading much of the risk onto retail investors. The SEC’s proposed regulations aim to rebalance the scales and provide increased transparency—which, for sponsors, makes starting a new SPAC less attractive.
Finally, there’s been a massive shift in economic sentiment in recent months. Tech stocks have gone from hitting eye-watering valuations to suffering a serious correction (the Nasdaq Composite is down 22% since the start of the year) and “recession” is the word on everyone’s mind. Inflation continues to climb at its highest rate in some 40 years and the Federal Reserve has hiked interest rates in response, making investors significantly more risk-averse. That’s all led to a slowdown in the global IPO market at large, from which SPACs have not been spared in the least.
It will be interesting to see whether SPACs are able to rebound alongside a general upturn in market conditions, whenever that may arrive. (It’s not looking great at the moment.) If they don’t—and if SPACs are resigned to becoming a relic of a particularly frothy economic moment—tech startups and other companies may have to devise new ways to tap the public markets. Or, you know, just resort to a traditional IPO. — David Shultz
Bird Is Reportedly Laying Off 23% of Its Staff
The layoffs at Santa Monica-based electric scooter firm were first reported by tech jobs tracking site Layoffs.fyi, which said it got access to an internal company memo.
Yohana, a Concierge Service for Families, Launches in LA
For $249 per month, Yohana promises to help its customers with everything from finding a plumber to planning a birthday party to buying baby food.
Calaxy Raises $26M To Bring Blockchain to Fans
This new Web3 social media app, co-founded by NBA player Spencer Dinwiddie, lets creators sell their own crypto tokens to fans, who can redeem the tokens for exclusive content.
‘Always Sunny’ Star Rob McElhenney Launches Web3 Startup
The actor and filmmaker launched Adim, a platform where creators can collaborate, come up with new characters and get a financial stake in their future success.
TikTok Introduces Its Answer to Snapchat’s Bitmojis
The video-sharing app, which has its U.S. offices in Culver City, is the latest social media firm to add avatars to its platform.
E3 Gaming Conference Will Return Next Year
After three years without an in-person event, the annual E3 video gaming convention will finally return next year—though it remains to be seen whether it will come back to its usual home in Los Angeles.
Miso Robotics Partners With AWS To Test Its Kitchen Robots
Food tech startup Miso Robotics has added a major new partner in Seattle ecommerce and cloud computing giant Amazon.
🎧 Listen Up! Melin Hats Co-Founder on Building a Business
On this episode of the PCH Driven podcast, the Melin Hats co-founder Brain McDonell joins the show to talk about losing everything, working when he was young and building his company from scratch.
What We’re Reading Elsewhere...
- GQ profiles L.A. gaming and esports conglomerate Faze Clan.
- MedTech Innovator unveils its new accelerator class of medical startups, including several from SoCal.
- L.A.-based BasePaws gets acquired by animal health company Zoetis.
- Santa Monica-based music tech company Songtradr acquires AI startup Musicube.
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