Harvesting (7th Fundamental of Early-Stage Investing)

The last step of any investment deal is a successful exit – Harvesting. Notice that this statement says nothing about profitability, but rather the ability to walk away from a given deal. In the aviation industry, specifically pilot training, there is a proverb that says “any landing you walk away from, is a good landing.” Most landings are smooth and uneventful, but this statement technically includes crash landing an airplane and surviving the crash. In this regard, harvesting is the same way, ideally, one would like a nice, uneventful, and profitable exit, but should not discard the real possibility of a negative exit. David Amis and Howard Stevenson describe harvesting as, “the endgame of early-stage investments, the financial score by which you will measure your success” (p. 287, 2001). With this thinking in mind, below are some brief descriptions and highlights regarding positive and negative harvesting scenarios.

Positive Harvesting Methods

According to Amis and Stevenson, there are five positive harvesting methods. Each method warrants a more comprehensive discussion; however, these basic definitions are a great starting guide to each concept.

Walking Harvest – The company distributes cash directly to investors on a regular basis.

Partial Sale – The investor’s stake is sold to management, to another shareholder, or to an outsider.

Initial Public Offering (IPO) – The company sells a percentage of its shares which are listed on NASDAQ, NYSE, or another exchange, creating a market for investor’s shares.

Financial Sale – The company is sold to financial buyers who purchase it for its cash flows.

Strategic Sale – The company is sold to an industry buyer who buys it for strategic reasons, such as marketing synergies.

Some of these methods are better than others. According to Amis and Stevenson, “contrary to all of the stories in the press applauding grand IPOs, strategic sales are the most common and often the most lucrative” (p. 289, 2001). This fact speaks to the need to analyze each deal individually and find the best fit. It is important to remember that sometime the most attractive option might not be the most optimal.

Negative Harvesting Methods

Consistently considering the fundamentals of early-stage investing will lead to positive results; however, sometimes failure is unavoidable. In such cases, preparation becomes front and center. Following with the earlier analogy, pilots train daily for emergencies, just like investors and entrepreneurs need to prepare for negative outcomes. Entrepreneur’s writer Martin Zwilling suggests investors and entrepreneurs should “[not] wait until you are in trouble to think about an exit, rather think of it as a succession plan, or a successful transition” (2011). The two negative harvesting methods are:

Chapter 11- The company is reorganized and the investors typically lose most of their upside; and,

Chapter 7- The company is liquidated and investors, depending on their place in line, get little or nothing.

Since harvesting plays such a central role in assessing investing success, it is important to have an exit plan in place. Amis and Stevenson suggest leaning on VC networks for guidance (if able), given the fact that they spend 75% of their time harvesting (p. 306, 2001). As with all other fundamentals of early-stage investing, practice makes perfection. Perhaps the biggest takeaway from this discussion on harvesting is to go into a deal with the exit in mind. In essence, angel investors need to ensure the necessary steps are taken to reach a positive exit once their role approaches its end.

References

Amis, D. & Stevenson, H. (2001). Winning angels: the 7 fundamentals of early stage investing. London: Pearson Education Limited 2001.

Zwilling, M. (2011, January 11). Five smart exit strategies. Entrepreneur. Retrieved from https://www.entrepreneur.com/article/217842