Wrapping up a success story – managing the exit
As the Hungarian JEREMIE funds are nearing the end of their investment periods, founders and investors should already start preparing for successful exists.
by Dr. Gábor Spitz
Attorney at law, Schoenherr Hetényi Attorneys at Law
For economies lacking natural resources, innovation can be one of the key factors in attracting attention and investments to drive economic growth. Since the end of the financial crisis Hungary’s unique startup scene has been at the focus of investment activity mainly driven by the European Commission’s JEREMIE (Joint European Resources for Micro to Medium Enterprises) initiative. With the funds winding up their investment activities in 2015, more than 200 companies received first-round investments from JEREMIE-backed funds in between 2010 and 2014, making up 72% of all venture capital investments in this period.
Given a typical holding period of five years, divestments are not expected to start before 2017-2019. This timeframe should give founders, management and investors alike ample time to dedicate their resources to the development of the products following a frantic period of investment dominated by networking, roadshows and transaction work. However, as the historical (pre-crisis) average in Hungary is eight to ten exits annually, the market may quickly become flooded with the investors and/or founders of JEREMIE-backed projects looking to divest. In such a saturated market, with a typical transaction timeframe of nine to 18 months, it is never too early to start preparing for the exit.
The first step in achieving a successful exit is identifying the most suitable type of divestment partner. In line with wider European trends, sales to strategic investors remains the leading exit route in the CEE region, with the share of secondary sales and public offerings in the region slightly behind European figures. Hungarian market players generally share the impression that strategic investors present the best exit opportunity for local venture capital investors and founders. Nevertheless, doing their homework to understand the relevant industry segment, the players on the wider market and the competitors will help prospective sellers to appropriately position their company and to approach potential acquirers in a targeted manner. Naturally, the choice will ultimately depend on the individual strengths and needs of the company, which will vary greatly even between entities in the same growth stage and industry segment.
Once the preferred exit route is chosen, founders and management will have to dive into the technical side of the transaction process. While conducting a formal vendor’s due diligence cannot be reasonably expected from a typical Hungarian JEREMIE-backed entity, knowing your business is nevertheless key to the effective management of a divestment. Identifying potential dealbreakers up front and at least being prepared to offer appropriate solutions may prove to be an invaluable asset during the negotiations.
Management should be aware of the internal resources they can rely upon (e.g. transaction specialists of the venture capital investor) and should also assess external support needs. Costs of management time and external advisors should be budgeted realistically, and, if needed, be factored into the pricing. Picking the right advisor can be time-consuming, exploring the market in advance will expedite the process and allow a realistic assessment of costs.
Internal and external communication and confidentiality aspects are also best assessed and agreed upon early: The ill-timed or uncoordinated disclosure of a potential divestment can create an atmosphere of uncertainty within the company and the counterparty’s loss of trust will have a negative effect on the success of the transaction. Similarly, the flow of sensitive information during the due diligence phase is a risk factor. Clean team, red data room and similar technical solutions can mitigate competition law concerns, but the technical details should be regulated well in advance, already in the term sheet phase.
To summarize, preparation is essential in achieving a well-timed, successful exit. Setting up a divestment timeline, identifying tasks and starting the implementation well before the planned exit date may divert certain resources from managing the growth of the company, but will pay dividends in the end in the form of a healthy return on investment and having the company in good hands for the longer term.
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