Thinking Of ExitsSanjay Anandaram
It is important for startups to appreciate the role of investors as stakeholders and partners in the creation of a successful and valuable business. And part of the appreciation should manifest itself in the realization that investors should get liquidity on their investment within a reasonable time period, usually 5 years. Just as the management of a public company is responsible to shareholders for delivering returns, the management of a startup too is responsible to its VC investors. Unlike investors in a public company who can sell their shares at any time on the stock exchanges (usually happens when they believe that the company’s future prospects are not very bright), a VC investor cannot do so since there’s no stock exchange market for selling his shares. Thus, the shares of the VC investor are illiquid for a period of time. In return, the VC investor gets certain rights. And it is the obligation of the management to provide an “exit” to the investor after a certain minimum period of time, hopefully profitably. Entrepreneurs who understand the role played by investors try very hard to find an exit for their investors. It is important to also understand the time horizon of the investors; entrepreneurs may want to go on and on with their business but need to understand that the investor has to generate a return on their investment within a specific period of time. Great entrepreneurs appreciate the role played by their investors and work in tandem with them to provide an exit.
An exit is a very important and critical element of a business strategy. In as much as entering a market/company has much to do with timing, exiting a market/company has more to do with it. An exit is an event that allows investors and founders of the startup to "exit" or cash-out of their respective investments (i.e. cash from the investors and usually “sweat” from the founders), hopefully with substantial profits. Exit events typically are of 2 types: an IPO (Initial Public Offering) and M & A (merger with another company or acquisition by a larger company). In some cases, “stake sales” where the VC fund sells its stake to another fund. Exits have to be planned, thought through and executed with as much finesse as executing operations. And both have a lot to do with timing. A great product offering with great execution and delivered by a great management team but released at the wrong time could kill a company. On the other hand, not exiting a company at the right time can cost a company, investors and management very dearly indeed. For example, an IPO requires an enormous amount of preparation, is expensive, requires resource commitments and has high administrative overheads before, during and after. An M&A exit too requires careful planning if a satisfactory exit is to result. Issues of taxation can be frustrating and expensive as well and play an important role in determining the appropriate structure of the entity for an optimum exit value.
When VCs and others consider business plans for investment they factor in the possibilities and likelihoods of an exit and the types of acquirers. Now, not all companies go public, so most investments have to generate returns through a M & A or a strategic sale. It is therefore important for the entrepreneur and the management team along with the investors to think through the various exit scenarios at different times in the company’s evolution and take decisions based on the prospects of the business at that time. Investors will want to cash out or exit if they’ve reached the end of their typical waiting period or if they believe that the company has achieved all that it could and there’s nothing more to be gained by waiting or holding on to the investment. That’s the cold and fair logic of the investor-entrepreneur relationship.
What do you think?