What are Exit Strategies?

If you’re thinking ahead to the day when you’ll no longer run your business, think about these five exit strategies now so you’ll be prepared for your future. Entrepreneurs live for the struggle of launching their businesses. But one thing they often forget is that decisions made on day one can have huge implications down the road. You see, it’s not enough to build a business worth a fortune; you have to make sure you have an exit strategy, a way to get the money back out. This is for those of you who like to plan ahead and for those of you who don’t but should.

“Entrepreneurs live for the struggle of launching their businesses.” 

Why Think about Exits

There are two very real and practical reasons why you need to plan an exit:

• Return for Investors. Remember that equity investments are not like loans with interest. The investor sees no return until he cashes out, or the company is sold. Even three years is a long time to wait for any pay check.
• Entrepreneurs Want to Do It Again. Assuming your startup takes off, you will probably find that the fun is gone by the time you reach 50 employees, or a few million in revenue. The job changes from creating to operating. You will be anxious to start a new entity, with new ideas and spinoffs that have built up in your mind, and certainty that you can avoid all those potholes you hit the first time around.

Common Exit Scenarios

These are the most common exit scenarios:

• Merger & Acquisition (M&A).This normally means merging with a similar company, or being bought by a larger company. This is a win-win situation when bordering companies have complementary skills, and can save resources by combining. For bigger companies, it’s a more efficient and quicker way to grow their revenue than creating new products organically.
  • Pros. The benefits of this strategy are:
    • If you have strategic value to an acquirer, they may pay far more than you’re worth to anyone else.
    • If you get multiple acquirers involved in a bidding war, you can ratchet your price to the stratosphere.
  • Cons.The risks of this strategy are:
    • If you organize your company around a specific be-acquired target, that may prevent you from becoming attractive to other acquirers.
    • Acquisitions are messy and often difficult when cultures and systems clash in the merged company.
    • Acquisitions can come with noncompete agreements and other strings that can make you rich, but make your life unpleasant for a time.
• Initial Public Offering (IPO).This used to be the preferred mode, and the quick way to riches. But since the Internet bubble burst in the year 2000, the IPO rate has declined every year until 2010, and is now at about 15 percent. I don’t recommend this approach to startups these days. Shareholders are demanding, and liability concerns are high.
  • Pros. The benefits of this strategy are:
    • You’ll be on the cover of Newsweek.
    • Your stock will be worth in the tens–or maybe even hundreds–of millions of dollars.
    • Your VCs will finally stop bugging you as they frantically try to insure their shares will retain value even when the lockout period expires (Warning: they won’t necessarily be looking out for your shares, too.)
  • Cons.The risks of this strategy are:
    • Only a very few number of small businesses actually have this option available to them since there are very few IPOs completed annually in the United States.
    • You need financial and accounting rigor from day one far above what many entrepreneurs generally put in place.
    • Some forms of corporation–S-corps, for example–will require a reorganization before they can be taken public.
    • You’ll spend your time selling the company, not running it.
    • Investment bankers take 6 percent off the top, and the transaction costs on an IPO can run in the millions.
    • When your lockout restrictions expire, your stock will be worth as much as a third world hovel.
• Sell to a Friendly. This is not an M&A, since it is not combining two entities into one. Yet it’s a great way to “cash out” so you can pay investors, pay yourself, take some time off, and get ready to have some fun all over again. The ideal buyer is someone who has more skills and interest on the operational side of the business, and can scale it.
  • Pros. The benefits of this strategy are:
    • You know them. They know you.
    • Your buyer will most likely preserve what’s important to you about the business.
    • If management buys the business, they have a commitment to making it work.
    • Selling to family makes good on that regrettable offhand promise made 30 years ago, “Someday, son/daughter, all this will be yours.”
  • Cons.The risks of this strategy are:
    • You can get so attached to being bought by someone nice that you leave too much money on the table.
    • If you sell to a friend, they’ll be peeved when they discover they just bought the liability for that decade’s worth of taxes you forgot to pay.
    • Selling to family can tear the company apart with jealousies and promotions that put emotion way ahead of business needs.
• Hand The Reins and Keep Collecting. Make it your cash cow. If you are in a stable, secure marketplace, with a business that has a steady revenue stream, pay off investors, find someone you trust to run it for you, while you use the remaining cash to develop your next great idea. You retain ownership and enjoy the annuity. But cash cows seem to need constant feeding to stay healthy.
• Liquidation.Even lifetime entrepreneurs can decide that enough is enough. One often-overlooked exit strategy is simply to shutdown, close the business doors, and liquidate. There may be a natural catastrophe, like 9/11, or the market you counted on could implode. Make rules up front so you don’t end up going down with the ship.
  • Pros. The benefits of this strategy are:
    • It’s easy and it’s natural. Everything comes to an end.
    • There’s no negotiations involved.
    • There’s no worrying about transfer of control.
  • Cons.The risks of this strategy are:
    • Get real; it’s a waste! At most, you get the market value of your company’s assets.
    • Things like client lists, your reputation, and your business relationships may be very valuable, and liquidation just destroys them without an opportunity to recover their value.
    • Other shareholders may be less than thrilled at how much you’re leaving on the table.

To some, an exit strategy sounds negative. Actually, the best reason for an exit strategy is to plan how to optimize a good situation, rather than get out of a bad one. This allows you to run your startup and focus efforts on things that make it more appealing and compelling to the short list of acquirers or buyers you target. Planning for your exit may seem premature, but the things you think about today can have a real impact on where you end up.