The Exit Equation: A Tool for Exit Planning and Value Creation
The Exit Equation is a financial formula used to estimate the potential exit value of a company at a specific point in time.
I’ve found it to be a helpful frame for companies that are working towards a first-class exit or are considering their funding and liquidity options, or growth initiatives, as it helps to identify the key valuation drivers.
The Exit Equation
It is expressed as:
Headline price = [unit] x [multiple]
Where:
Units: the economic unit being measured (e.g. revenue, EBITDA, or in a strategic sale, it might be number of customers or users etc.)
Multiple: the valuation premium applied to the Units (e.g. the multiplier used to capture the current and future value)
In essence, it translates various abstract qualities of a business into a concrete number, allowing for a quantified assessment of the company's potential exit value.
Worked Examples
Software Company Example
A software company with $10 million in recurring revenue and a multiple of 7 (based on its market position and growth rate, etc.) would have a potential exit value of:
Headline price = $10 million x 7 = $70 million
Ecommerce Company Example
An e-commerce company $5 million in EBITDA and a multiple of 8 (based on its market position and growth rate, considering repeat purchases and other factors) would have a potential exit value of:
Headline price = $5 million x 8 = $40 million
Notes
I find it helps to have a margin of safety in the input assumptions.
The choice of unit is often aligned with the company's industry, stage of maturity and the core drivers of value within the business.
The multiple reflects a variety of qualitative and quantitative elements, including the company's position in its market category, competitive strength, growth rate, operational and financial metrics, together with the perceived attractiveness of the company, both now and over time.
Sometimes an exit is based on a completely different metric (e.g. number of customers/users or depth of product/technical breakthrough/IP). However, this is more common for companies that don’t have meaningful revenue and have deep value to the buyer in another form.
There are often adjustments to the headline price (e.g. net cash/net debt) and holdbacks (warranty, earn out etc.), with various multipliers or discount factors that come into play, affecting the final value.
Other elements are just table stakes (e.g. IP ownership, quality due diligence materials etc.).
Benefits and Limitations
The Exit Equation works well for established or growing companies that have a reasonable level of scale and/or are working towards an exit or liquidity.
Benefits
Simplifies complex valuation factors.
Provides a tangible measure of a company’s potential worth.
Facilitates strategic planning and decision-making by identifying key value drivers and areas of improvement.
Limitations
Requires accurate and relevant data for precision.
May need to be adjusted for market changes.
Potentially does not incorporate the unique characteristics of the business.
Conclusion
By understanding the components and drivers of the equation and considering your company’s unique aspects, founders of established and growing companies can use the Exit Equation, together with Contributed Capital Return and Rule of 40, to help make better decisions on value creation on the path to being Truly Great or when working towards a first-class exit.
