Like any company investment, knowing when to exit is most often a decision based on proper timing. Knowing when the timing is right is usually a judgement call for management. Nowhere is this more explicitly true than in software and internet deal valuations multiples. A few of rules of thumb are helpful, however, in knowing when is the time to jump ship.
After a company has begun experiencing high growth and future growth can be much more accurately valued, then is the time to exit. Usually this cannot be fully done until the company has gone public and the aggregate market does a great job of fully valuing the company. Generally the aggregate market will value the company based on the alance of total return or multiple on investment and the annualized return over the investment time period. Here are some other key pointers:
Since the majority of investors’ time, money and resources are spent on companies which may not be growing at break-neck speed, it doesn’t necessarily mean such companies will ultimately fail, are bad investments or need to be sold. It probably means the companies are much more normal. However, it is important to remember that returns are based on grand slams to compromise for the write-offs.
The most strategic time to think about doing M&A in Software is when an industry is experiencing consolidation or performing massive roll-ups. In this scenario it’s best to be involved at some level by either gobbling up other companies or finding a strategic target to buy assets, revenue and customers. In most cases, especially if you look at options from an investor’s point of view, it’s best to become a target for acquisition unless the company’s position in the marketplace is one of absolute dominance. In software, in particular, buying companies for consolidation is an expensive play and a risky bet, since new technologies are always coming to market and may eventually greatly affect your investment’s ability to succeed.
There is no definitive game plan for when to sell a position in any company, but a few rules of thumb may help to guide investment decisions and to know when the timing is ultimately right.