Deciding when to sell your startup is one of the most complex and consequential choices an entrepreneur can face. There’s no universal formula, as it depends on a myriad of personal, strategic, and financial factors. However, I’ve found that a simple rule of thumb can provide a useful framework for evaluating potential acquisition offers.
Assessing Your Startup’s Future Potential
The cleverest answer I’ve heard to “When would you sell your startup?” is “When somebody offers me more than I think it’s worth.” While clever, this meta-answer sidesteps the core issue of how to determine your startup’s true value. In this article, we’ll explore a more practical approach.
The fundamental question is: How much risk are you willing to take on to pursue your startup’s future potential? Building a successful company is notoriously difficult, as one founder often quips, “not just harder than you think, but harder than you can possibly imagine.” As someone who has played a leading role in four enterprise software startups, I can attest to the immense challenges involved.
So, if someone is willing to pay you today what you believe your company will objectively be worth in three years – assuming everything goes exceptionally well – that’s an offer worth serious consideration. After all, you’d be trading away your startup’s bright future in exchange for taking a substantial amount of risk off the table.
The Three-Year Rule
My simple rule of thumb is this: You should consider selling your startup when an offer takes three years of operating risk off the table.
Why three years? Because a lot can happen in that timeframe. New competitors may emerge, the market could consolidate, your product development could hit unexpected roadblocks, or key hires may not pan out as planned. While you may be confident in your ability to execute and achieve your three-year projections, the reality is that startups face a multitude of unpredictable challenges.
At the three-year mark, I start to carefully weigh the strategic and operational risks ahead. Even if you believe your company is poised to outperform its forecasts, you have to honestly assess whether the potential upside justifies the continued risk. This calculation becomes especially important if the acquisition offer comes from a larger player who may be intent on entering your market regardless.
Another crucial factor is the current market environment. If valuations are at historically high levels, an offer today may represent a much better outcome than what you might achieve in three years, when market conditions could have shifted. A hypothetical example: If you’re offered 10x your projected $50 million in revenue, but by the time you actually reach that milestone the market is trading at 6x, that’s a 40% reduction in value – all because of market movement, not your execution.
A Concrete Example
Let’s run through a concrete example to illustrate the three-year rule in action:
Imagine your startup is currently generating $15 million in annual recurring revenue (ARR), growing at 107% year-over-year. Based on your projections, you expect to reach $50 million in ARR in three years, with the need to hire an additional 35 account executives (AEs) to make that plan work.
Now, let’s say someone offers to acquire your company for $675 million. That’s a 45x multiple on your current ARR and a 22x multiple on your projected Year 3 ARR. Given your current $15 million ARR and 107% growth rate, your company is already worth around $233 million today (using a 15x multiple).
Using the three-year rule, this $675 million offer would be worth serious consideration. It’s effectively taking three years of operational risk off the table – the work and uncertainty involved in growing from $15 million to $50 million ARR. That’s a significant risk reduction that you’d be trading for a premium valuation.
Of course, this is just a simplified example. You’d still need to carefully weigh the personal and strategic implications of selling your startup. But the three-year rule provides a useful framework for assessing whether an acquisition offer is worth exploring further.
Addressing Potential Objections
I anticipate a few potential objections to this approach:
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“But what if my company is poised to significantly outperform that three-year projection?” This is a valid concern. If you have strong conviction that your company will vastly exceed its forecasts, then the three-year rule may not apply. However, I’d caution against overconfidence – startups often face unexpected challenges that can derail even the most ambitious plans.
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“Shouldn’t I hold out for the absolute maximum valuation possible?” While maximizing value is understandable, it’s important to balance that with risk reduction. The three-year rule is about considering offers that significantly reduce your operating risk, not necessarily about capturing the absolute highest valuation.
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“What if I’m not ready to sell, even with a great offer?” Selling a startup is a deeply personal decision. The three-year rule is not a mandate to sell, but rather a framework for evaluating offers. You may ultimately decide that the potential future upside outweighs the risk reduction, and that’s a perfectly valid choice.
The purpose of this article is to provide a rational, objective framework for thinking about startup acquisition offers. By focusing on the number of years of risk taken off the table, you can make a more informed decision about whether to consider a particular offer. The rest is up to you and your board to weigh the personal, strategic, and financial factors at play.
Ultimately, selling a startup is one of the most complex and high-stakes decisions an entrepreneur can face. But by applying a simple rule like the three-year rule, you can gain valuable perspective and clarity as you navigate this challenging landscape.
