Entrepreneurs? Launching a start-up? The first question you should ask yourself is what is your exit strategy. If you do not know the answer, you should stop and make a plan, because your exit strategy is your company’s success plan.
What’s the significance of planning an exit strategy early?
- It facilitates expectation management between all the companies’ entrepreneurs in order to prevent future disputes.
- It could influence the founders’ agreement, the company’s articles of association and the like, as well as its capital structure, and assist in developing a proper strategy in terms of the company’s IP.
- It could impact the new company’s ability to raise funds from investors. Investors seek to know your exist strategy as they may rely on you to know how to develop the technology and reach the market, but they may not necessarily trust you to do the hard and labor-intensive work of production, marketing, sales and services.
Investors know that the profits of investing in start-up companies are made only in case the company achieves an exit. As a result, they are not interested in entering a company that does not know how to materialize its assets, let alone with its founders have no intention to reach an exit and give investors the expected return on their investment.
Sadly, not all entrepreneurs understand the importance of the exit as what yields return on investment. There are many entrepreneurs that take the “life style exit” approach whereby they withdraw funds from the company through high salaries and benefits at the expense of investors, but mostly at the expense of the company’s growth – a company which they launched and are running – until its slow demise.
An “exit” does not necessarily mean you must abandon the company you established at great efforts. Indeed, when the exit is done by way of selling the company to a third party, the terms of the sale agreement may often require you to stay for a minimum period of between a year and three years after the company’s acquisition, in order to ensure continuity and creation of value for the purchaser.
In the event of selling the company to a third party, its founders often enjoy continuing to develop the company and spend an additional long period of its career there, even though they no longer own it. In such instances, founders may enjoy much better conditions than they had prior to the sale of the company.
In contrast, if you are founders of the “serial entrepreneurs” type, you might seek to take advantage of the sale of the company to start something new.
The common exit options are:
- If you are counting on an investment by venture capitalist in your start-up, remember that such investment limits you as to the type of exit you can do. Usually, venture capital funds limit you to two types of exits: a sale (including a merger) and an initial public offering (IPO) in which company shares are issued to the public. Because of the terms for investment by investors in venture capital funds and their own internal regulations, they are limited in terms of the period in which they would seek a return on their investment, a requirement that may be met only by executing a sale or an IPO.
- If the investors in your start-up are angel investors or various private investment funds, you have other paths for to exit such as royalties or dividend distribution.
As noted above, except for under unusual circumstances, venture capital funds are not interested in profits from royalties or dividend distribution, because generally the time constraints they are under mean they cannot receive the same rate of return on investment as they would like. However, if you can demonstrate that your company can produce huge amounts of available cashflow, which would permit you to return the investment funds within a year or two and then later maintain that high cashflow, you might persuade not only private investors but even a venture capitalist investing in your company to agree to this type of exit.
Remember that though it is important to determine an exit plan early on, this does not mean that you must blindly follow that plan. Ultimately, your exit strategy is impacted by short term trends in the market in which the company operates, the financial markets, and the economic status.
Should the IPO’s market be hot, an IPO may be a good option. If there are big companies in your field with great cashflows, merger with such a company or being acquired by it may be your best strategy. After all, a successful exit is your best avenue to contribute to the industry in which you operate, to encourage investors to invest in it, build your good name as entrepreneurs and ensure your financial wellbeing.
For more information, contact a member of our HIGH TECH team.
Source: barlaw.co.il