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May 31, 2022

Don’t Let Turbulent Markets Stop You from Planning a Smart Exit Strategy

Stock market on laptop, tablet and phone

So far, 2022 has been a dismal year for IPOs, especially compared to last year’s record-setting activity. According to PwC and Dealogic, only 8 traditional IPOs (as distinct from SPACs) were filed in the first quarter of this year, raising $2 billion. That was an 88 percent decrease in volume and a 94 percent drop in proceeds from just the prior quarter (Q4 2021). And many of the companies that went public last year have seen their share prices fall, sometimes precipitously.

The reasons are clear. Even before the Russian invasion of Ukraine, investors were concerned about inflation, supply-chain disruptions, the direction of interest rates, the cost of energy, and lingering traces of the COVID-19 pandemic. The European war has added geopolitical instability to the list of uncertainties. And as everyone knows, markets abhor uncertainty.

graph of ipos

Despite these market headwinds, we at Norwest are actively working with our portfolio companies to identify and capitalize on the best strategies for growth, realignment of resources, and exit.

‘Wait and See’ May Be Too Passive

On the growth equity side, we are naturally inclined to look for exit strategies, but we recognize that profitable companies do not necessarily need to do anything if market conditions indicate it might be best to sit things out. There’s a strong temptation for management and investors to look at comparable companies that sold last year for market-topping revenue or EBITDA multiples and sit tight until that number can be achieved.

But that may not be the best strategy. It could be akin to a homeowner who’s bound and determined to “get my price” irrespective of changes in the market. Companies and their backers must constantly assess market conditions and avoid single-minded approaches.

While the current environment is causing us to be more patient in some cases, we are no less diligent in seeking opportunities. For example, even as valuations may have come down dramatically in the public markets, there is still a lot of private equity money. As a result, some of our exits probably will tap that source of funding, at least in the near term.

And, at Norwest, we invest in a number of minority recapitalizations every year where friends and family or early investors might have a need for liquidity, but you as the founder are just fine to hold on to your ownership. If cash flow positive, there is no need to raise money for the balance sheet in today’s market — that might feel dilutive — but the downturn could be an opportune time to clean up your cap table and bring in an experienced partner.

Inflation Complicates Valuation

One factor we haven’t needed to consider for a long time in setting exit strategies is inflation. In the case of many young or even middle-aged investors and executives, inflation has never been an issue. But today it is. The sharp increase in inflation affects both timing and valuations.

Many of our portfolio companies are raising prices due to rising costs. We are encouraging them to do so, because waiting may negatively impact margins and/or result in sharper increases in the future.

But inflation always raises the question of whether top-line growth is coming only from price increases or from growing sales as well. Analysts and potential institutional and retail investors must determine if a business really is a growth company — and at what level — to calculate the multiple they feel comfortable paying.

Talent, M&A Add to Value

Even if management and institutional investors are in a wait-and-see mode regarding exit plans, companies can take steps to add value that will increase returns upon exit.

One of those steps is to evaluate the quality of talent at senior levels: in the C-suite, at the VP level, and on the board. While our typical portfolio company is the brainchild of one or two founders, a strong leadership team is always a requirement for success. We’re very founder-friendly, so helping put the right talent around them is a key step in helping achieve growth targets and thus raise value. With high-profile technology companies announcing layoffs, now could be the perfect time to find top talent to add to your team.

As invited guests, we counsel management to evaluate the strengths and weaknesses of every senior executive honestly and openly to determine if they are making an optimum contribution to growth and success. To aid in this ongoing process, we have an amazing in-house talent and recruiting team whose services are part of our complimentary Portfolio Services offering. Every portfolio company that has used the team’s services has benefitted from their contributions.

Another route to adding value is through M&A. Even a young private company can execute an acquisition to meet a strategic need, including:

  • filling a hole in a product line
  • implementing a buy-versus-build approach
  • obtaining critical technologies
  • entering an adjacent market
  • lowering sales and marketing costs
  • consolidating the supply chain to reduce costs and speed time-to-market

M&A advice is another of the Portfolio Services (like talent acquisition) that Norwest offers to our portfolio companies.

For example, one of our portfolio companies is SmartSign, which sells a broad range of signs, tags, mats, and labels through more than 40 websites. Since Norwest invested in the company in 2019, it has done four acquisitions to vertically integrate operations, leading to accelerated growth and improved margins. SmartSign’s Founder, CEO, and President, Blair Brewster, is a strong believer in aligning financing strategies with changing business conditions. “It’s certainly less overwhelming, knowing that we have a large, steady, and experienced team from Norwest behind us during these times,” he says.

The Importance of Timing

Finally, timing is always a critical element in setting and executing an exit strategy. One factor in timing, of course, is the overall state of the equity markets. The progress of product development and new product introductions can also influence perceptions of a company’s value. And strengthening the management team, completing an acquisition, or entering a new market can all be contributing factors to determining exit plans.

We can’t always predict when turbulent times will come or how long they’ll last. But that doesn’t prevent us from staying focused on the role we play: partnering with our portfolio companies to help them grow and succeed; always looking for ways to add value to the business; evaluating multiple options for an exit; and contributing our experience and expertise to make the chosen strategy a success.

Note: This blog post was inspired by a great panel I participated in with other women investors in the mid-market M&A space. Watch the full discussion below.

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