Why Your Startup Should Have an Exit Strategy

Note: For the infographic head straight to the end of the post!

You know what the goal is? That you don’t become like the guy above running close to tears when the temperature gets too high.

Even though it may sound negative, an exit strategy is a necessity of every startup. As Investopedia defines it, an exit strategy is:

The method by which a venture capitalist or business owner intends to get out of an investment that he or she has made in the past. In other words, the exit strategy is a way of “cashing out” an investment. Examples include an initial public offering (IPO) or being bought out by a larger player in the industry. Also referred to as a “harvest strategy” or “liquidity event”.

Just as you have strategies for different contingencies, you have to have one for the day you start wishing for an out or get an offer you just can’t refuse.

I’m here for the long haul. Why would I want out?

Ok, we did not think that you started your company with the goal of having a yacht by the time you were thirty, but if it ever comes a time when you want to change things, that will be borderline impossible without a plan.

Humor me on this. Imagine some of the following scenarios:

1. After 5+ years of every-hour workday, the only thing you want is to get some sleep. They say you don’t know what tired is until you start running a startup, now imagine doing it 5 years in a row.

It is speculated that oDesk founders sold their company to Elance just because they were bone-deep tired. These things happen, especially if you don’t have a strong backup to share the load with. But when you get too tired, or too stressed or just fed up with everything, quitting is not easy. You can’t wake up one day and decide not to come to work anymore. You have to have an exit plan put in place.

2. You get a crazy good offer to sell your business. Your business is doing great, it’s showing even greater future potential and a Big Guys Inc. decides they want it in their portfolio. They offer you four times your yearly revenue. What’s your response going to be?

At the very start, you have to have an exit amount in your head that has to clear no matter what. As you get bigger and as your opportunity costs grow, that amount will probably grow as well, but you have to start somewhere.

3. After three months of negotiations and meetings with investors, you hear: “We are sorry, but your lack of exit strategy is a deal breaker”. The reason for investing is getting your return, and investments in startups are among the riskiest. If you invest in a bond or a loan you know you will get your interest and when. With a private company, things are different. You can have a highly valued startup but still be broke. It’s not nearly as easy to get your share in a private company, as it is when it’s publicly traded. Which means you might have all that money on paper but cannot access it. Investors what to know when and how they can get their investment back.

4. You want liquidity in your life. You may want to pay off your mortgage or reach a point when you can go to pension early. Ok, who are we kidding, you are unable to sit still but you may want that “choose not to work” freedom. One option? Cashing out your share in the company or one part of it.

5. Maybe it’s just time for the next chapter in your life. Entrepreneurs are free sprits always looking for a new adventure, something that will challenge you and keep you on your toes. After three years of working on your startup and it reaching a point when you can instill new management and know it will work great, maybe you want freedom to try something new.

Ok, ok, what are my options?

They say that before you decide on anything, you should make a pros and cons list. However, when it comes to choosing exit strategies, advantages and disadvantages of each are very subjective. Basically, what you consider an advantage or disadvantage will depend on what you want out of your business and its exit strategy. So, before we explore each option in detail, Inc.com magazine suggests you ask yourself:

• What do you want your future role in the business to be? Consider whether you want you and you management team to stay in charge of the company after the exit strategy implementation or not.
• Do you need cash fast? Not all options will allow you to turn your share in the company for cash right away so that is also something to keep in mind.
• What do you think the future has in store for your company? This is where you consider your company’s current standing in the market but also it’s future. Do you foresee game changers in the industry or is that game changer you? Do you want to stay strategically involved in the managing the company or not?
• Does it feel right?  The last thing you should ask yourself is what is your gut telling you. Exiting a startup that you spent every moment thinking about for the last several years, or even decades, is not an easy choice. Be honest with yourself about your reasons for exiting and never decide on it under pressure.

Most Popular Exit Strategies

Now that you know what you want out of your exit strategy, choosing the one that fits best should be fairly easy. These are the key characteristics of most popular exit strategies:

IPO or Initial Public Offering refers to the first time a company sells its shares to the public.

• You have a choice of how big a part of your company you want to offer on the public markets.
• Your investors have the opportunity to sell some or all of their shares and get a return on their investment.
• However, if you are in a hurry for very liquid assets IPO might not be your best choice. It is very likely that your shares will be subject to a share lockup agreement, which will prevent you to sell your shares for a certain amount of time.
• Management vise, everything stays the same, at least for the foreseeable future. Essentially, you stay in charge.
• Your company becomes subject to many regulations and requirement by Sarbanes-Oxley, Wall Street analysts and institutional investors who will be scrutinizing your company performance on a quarterly basis. If you are not ready for the scrutiny and performance evaluations, reconsider on your strategy.
• IPOs have been known to fail. If your company doesn’t have enough market value and is not regarded a good investment, your shares may end up being lot less valuable than what you counted on.
• However, there have been some major successes. An average IPO-bound startup raises about $467.9 million!

M&A or Mergers and Acquisitions is one of the most popular strategies because it helps saving a lot of resources.

• Basically, another company purchases your business for cash, stock or the combination of both. No matter the option, your liquidity is increased immediately as one part of the payment is paid out at the start.
• Your investors will also get their share of the cake.
• You lose control over your company. If you want to stay part of the management team, this may not be the best option for you. Acquiring companies most often put their own people in charge. Of course, it all depends on the agreement.
• There is always the option of buying your company back if you see it’s not going in the direction you wanted, just like Tony Conrad did with about.me.

Management buyout is a less popular option that often happens with the turn of management.

• You sell your company to the next generation of managers, which means you are no longer part of the management team.
• This is the most seamless ownership transition option since the next generation of managers is already respected and trusted by the rest of the company.
• Liquidity of your shareholders increases immediately.

Now that you decided to exit your startup on your own terms, it’s never too soon to start preparing. The strategy you choose will direct many of the decisions you make next, from establishing your financial reporting system to choosing your investors, so let’s get started!

To see the exit strategies and outcomes of the biggest startups in the world, check out our infographic.