An exit in a startup is the process by which investors withdraw from the company, i.e. sell their stake in the business, and it is a key component of business exit strategies. Typically, an exit occurs when a startup has reached a certain level of maturity or value. This allows the parties involved in the deal to reap the financial benefits of their investment. It is through exits that investors make money directly.

Investors make exits for several reasons. The first is to make a profit. The main objective of investors is to generate income. An exit allows them to cash in on their investment by selling their stake or shares at a higher price than originally.

The second is to fulfil an investment strategy. Venture capital funds have a clear time frame for their investments, so keeping money in a startup forever is impractical. Sooner or later, investors need to exit to return funds to their LPs (and themselves).

Investors can use the money from the exit to fund new startups. In other words, the idea is to move capital into new investment opportunities.

Risk diversification should also be considered. Startups are risky investments. An exit allows investors to lock in profits and reinvest in other assets.

Investments in startups always have a limited timeframe, so the exit and its likelihood are discussed at the very beginning. The exit marks the end of the investment cycle.

What are the different business exit strategies?

There are three main types of common exit strategies: M&A, IPO, and secondary sale. A well-defined business exit strategy is crucial for guiding the course of a business and ensuring a successful transition.

Secondary sales are the most common strategy. Investors sell their stake in a startup to other investors. Usually, this form of exit occurs when a startup raises a new round of funding. However, technically it is possible at any time.

Merger and acquisition (M&A) is the next most popular exit. A startup is sold to another company, often bigger and richer than itself. A large company may want access to new technology, a presence in a new market, or simply to get rid of a potential competitor.

On the other hand, initial public offerings (IPOs) are the least common. A startup becomes a public company by listing its shares on a stock exchange. This allows founders and investors to sell their shares on the open market. An IPO is a media event and, in theory, makes the most money. However, few startups reach this level because it is incredibly difficult and time-consuming.

Let’s look at each type in more detail.

Secondary Market Sell Exit Strategy

A secondary market is the process of selling shares or a stake in a startup to other investors or interested parties. Unlike an IPO, the shares are sold on the private market rather than on a public stock exchange.

The current market conditions and the specific industry performance can significantly influence the success of a secondary market sale.

A secondary market sale is a common process for startups where early investors sell their shares to later ones. The buyers are interested in acquiring a promising and proven company. In fact, it can be argued that startups benefit from the rotation of investors. The point is that at every stage of a startup’s life, it needs a fund that can best help it not only with money but also with expertise and networking.

Among the benefits of selling on the secondary market:

• Liquidity. Ability to sell shares without waiting for IPO or M&A;
• Less regulatory requirements. A secondary sale requires far fewer disclosure and regulatory obligations than an IPO;
• Flexibility. Sellers have more control over the terms of the sale, including the selection of buyers and the agreement of a price.

However, there are disadvantages. For example, investors may have difficulty finding buyers. Everything depends on the development and performance of the startup, as well as the state of the market and the specific industry.

If a startup does not have enough stars in the sky, other participants may simply not come to a new round to attract investment. This will lead to down rounds, which will affect the value of the company and the shares of the current investors.

Mergers and acquisitions (M&A) Exit Strategy

Why do some companies buy other companies? To avoid competition, to innovate and to diversify their assets. For example, they may acquire competitors so that they no longer pose a threat, or they may buy startups with advanced solutions, technology and a skilled team for their own benefit. A startup is sold to another company, often bigger and richer than itself, through a strategic acquisition.

Mergers and acquisitions improve overall business performance as each company leverages the strengths of the other. For startup founders and investors, such a sale is a strategic move to secure a return on investment.

The success of an M&A deal often depends on the capabilities of the management team to integrate and manage the new business effectively.

There is even an investment strategy to create startups specifically to sell to large corporations. The startup doesn’t even have to be profitable. Enough of the technology that the corporate giants definitely need. Another reason for M&A is to get rid of distressed assets.

The M&A process can vary from deal to deal, but in general, it involves the following steps:

1. Strategic planning. Identifying and analysing potential buyers or sellers. A startup may receive an M&A offer and react to it based on whether a deal is needed or not. It is assumed that if such an opportunity is offered, it is a good sign for the company as there is demand and therefore value;
2. Initial valuation. Analysis of financials, market position, technology, customer base and other key factors. Determining the preliminary value of the business and the terms of the transaction;
3. Due diligence. A detailed analysis of the company’s financial statements, debts, assets and liabilities, reviewing legal aspects including contracts, litigation and regulatory issues. This includes an evaluation of business processes, management, human resources and other operational aspects;
4. Structuring the transaction. Deciding whether it will be a merger, acquisition, asset purchase or other form of transaction. Identifying sources of finance (equity, debt, etc.);
5. Finalizing the deal. Final terms are agreed between the parties, including price, payment terms, warranties, and covenants. This is followed by the formal signing of legal documents recording the terms and conditions;
6. Regulatory approval. Submitting the necessary documents to the regulatory authorities to obtain approval for the transaction. Obtain clearance or resolve antitrust issues;
7. Closing of the deal. Transfer of assets, disbursement of funds and fulfilment of other financial obligations. Completion of all legal and administrative formalities;
8. Integration. Develop and implement a business integration plan, including the combination of systems, processes, teams, and cultures. Monitoring the implementation of the integration plan and optimising the new structure.

It should be noted that M&A is a long and complex process that can take anywhere from six months to a year and a half. Working on the deal will be a second full-time job for both the startup team and its investors.

Initial Public Offering Exit Strategy

A public offering, often referred to as an initial public offering (IPO), is the process by which a private company brings its shares to the public on a stock exchange. Once a company goes public, its shares can be bought and sold on the open market. There are two ways of becoming a public company:

• IPO — taking a company public with the help of underwriters;
• SPAC — merging with an ‘empty’ company that is already listed.

Of these two options, the IPO is now the more common, so let’s look at the process in more detail:

1. Preparation. The company hires an investment bank to advise and organise the stock market flotation. Also at this stage, the main terms of the share offer are determined and the necessary legal and financial documents are prepared;
2. Registration and approval. The company applies to the relevant regulatory authority (e.g. the Securities and Exchange Commission or SEC in the US) for permission to go public;
3. Marketing and pricing. Company representatives and banks meet with potential investors to present the company. Demand from the latter helps determine the share price;
4. Placing of shares. The company’s shares begin trading on the stock exchange.

Going public is considered the pinnacle of a company’s development and hardly the most desirable exit option. The reason for this is simple — the ability to help develop a company into an IPO has a positive impact on the fund’s brand. In addition, the company’s capitalisation can increase many times following a successful IPO.

There are also some risks. These include transparency and cost. Public companies are required to disclose a significant amount of financial and operational information, which can hurt the share price.

In addition, a revaluation of shares during an IPO can lead to a dramatic fall in their value, reducing the funds raised. In addition, the share price of public companies is volatile and depends on many internal and external factors, in particular the state of the economy.