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Exit Strategies – Are They All the Same?

exit strategiesWe’ve said it before, but it’s worth repeating: Entrepreneurs and startup founders have a lot on their plates. They must often wear many “hats” and fill many roles across the organization as their company grows. That said, while their focus may be primarily on scaling the business and on overseeing day-to-day operations, it’s important that they still keep an eye on the future – and the eventual exit.

Exit Strategy: Also called a liquidity event, an exit strategy is an entrepreneur’s strategic plan to sell his or her ownership in a company to investors or another company or otherwise reduce his or her stake in the business. It is also commonly an investor’s way of seeing a return on investment (ROI) in a company.

So while there are many types of exits, how do startup founders know which one is right for their business? Are all exit strategies the same?

  • Liquidation: Essentially, to liquidate is to shut down operations and sell off assets. This may be an option if something catastrophic happens to the market or to the company itself. Alternatively, founders could choose to liquidate over time in the case of a “lifestyle company,” where they use the company’s profits instead of reinvesting them back into the company for growth. While this exit is relatively simple for founders, it offers the lowest ROI to investors, reduces the growth potential (and potential sale value) of a company, and can potentially hurt a founder’s reputation if he or she aims to begin another business venture. Founders will also need to consider investors’ liquidation preferences, or what dictates the capital that must be returned to investors before shareholders can receive returns in the case of a liquidation event.
  • Selling the business to a friendly party: A founder may choose to sell the company to another individual, such as a family member, company manager, or current employee(s). This can allow founders to preserve the core of their business while passing it on to someone who can operate the day to day. That said, passing the business to a family member requires the creation of a succession plan – a process that may be hotly contested when facing difficult family dynamics. Likewise, arranging a long-term buyout by employees can increase loyalty and motivate staff – but necessitates the current owner stay at the helm over a longer term. This strategy may also be more appealing to any outside investors, as the company continues operations as opposed to simply shutting down as in a liquidation.
  • Private tender offer: A tender offer is an offer to purchase some or all of a company’s shareholders’ shares, and the price per share is usually at a premium to the market price. A private tender offer can provide liquidity to shareholders while also allowing the company itself to oversee how many shares are sold, the timing of the sale, and who participates in the transaction.
  • Acquisition: An acquisition is when one company obtains ownership of another entity’s stock, equity interests, or assets. This can be done for a multitude of reasons, such as the purchaser’s desire to expand or to eliminate competition. Unlike in an initial public offering (IPO), the purchasing price is not dictated by the current state of the market, which means the company to be acquired has room to negotiate valuation. If the acquiring company decides to keep current employees on board, it may have drastically different cultures and systems that can make the transition difficult for everyone involved. Alternatively, it also may decide to eventually close the business down entirely. To plan for an acquisition, a founder should position the business as an attractive asset – or potential disruptor – to current businesses within similar industries.
  • Merger: Similar to an acquisition, a merger is when two companies agree to become one single company, merging their assets and becoming an entirely new entity. This can aid both companies in gaining market share, expanding into new markets, and removing some of the competition. After a merger, shares of the new company are often distributed to existing shareholders of both original businesses.
  • Going public: The most headline-grabbing exit strategy, going public – traditionally in the form of an IPO – means the company becomes publicly traded, is listed on an exchange, and is subject to an entirely new array of regulations. Unlike a merger or acquisition, going public entails convincing hundreds of individuals that the company has long-term potential. The process is also extremely time consuming, expensive, and not suited for every enterprise. Depending on how an IPO (or direct listing, in the case of MicroVentures’ portfolio company Spotify) is structured, founders may not be able to withdraw any capital for a period of time – and investors can be subject to a lock-up period. That said, going public is one of the best ways for investors to potentially see a big return on their initial investment.

While planning an exit strategy may go overlooked in some startups, it plays a key role in determining a company’s strategic direction. By not proactively planning an exit strategy, business owners and their successors may find that future options are limited.

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