Business Exit Reasons and Strategies
An exit occurs when an owner decides to end his involvement with a business. Most often such an exit is accompanied by a sale of the owner’s stake in a company, but this is not a necessary condition. For example, an entrepreneur may hire a management team to run the business but still retain his equity. Depending on the circumstances under which the exit occurs, the shareholder can either make a profit or a loss. This article provides an overview of the types of exit available to entrepreneurs and discuss when you should consider one.
It is often useful to start planning for an exit in the early stages of the company’s life. Whether the aim is to have an IPO, to quickly get acquired by Google or to pass on the family business to children, early planning will help founders structure their business towards their desired outcome.
Your exit strategy can influence many aspects of your business such as its legal structure, the types of revenue models you should adopt, the tradeoffs between investing for long vs short-term growth, the types of investors you should seek, etc. Even if you exit the business because of burnout, business failure or boredom with your company, it still pays to plan in advance for the exit. By thinking rationally about various exit strategy from the outset, entrepreneurs can maximise their take home return on their investment and sweat equity.
It is important to plan you exit strategy as early as possible
Even if you have no intention of exiting your business in the near future, it is important to think through your options and have a strategy in place. There are two main reasons for this. First, a concrete exit plan allows external investors to make realistic calculations of the timeline and likely rate of return on their investment, increasing the chances of investment by an angel or VC. Secondly, deciding how you want to exit enables you to structure business so that it optimizes your return in case of such an exit.
Most equity investments by angel investors and VCs are reliant on the successful business exit in order to see a return on their investment. This means that entrepreneurs are extremely unlikely to raise equity funding from external investors unless they cover exit strategy in their pitch and business plan. Entrepreneurs should research and know by what means and how soon similar companies in similar markets have been able to exit. In the context of externally-funded startups, most often this will be through acquisition by a larger firm and occasionally through an IPO. Additionally, business owners should give investors an idea of the scale of their possible return.
If you want to be acquired, you can increase your attractiveness to large corporations by being the first mover in your field and dominating your niche. Given that your core team will be acquired as part of the transaction, boost your business’ value by hiring and retaining a talented core team. To reduce the chances of a minority investor resisting your acquisition plans, make sure all your investors are firmly on board with your exit plan. The company acquiring you will also appreciate it if your business doesn’t have too many shareholders, as this reduces deal complexity and potential roadblocks. Working with one or two large investors, rather than many smaller ones, will make you a more attractive acquisition target.
If your exit plans involve stepping back from day-to-day operations and turning your company into a cash cow, you’ll want to look for a business model where the business is not dependent on you. This will require you to establish a model that is systematized so that it functions the same way every time, and can be run by ordinary people without requiring super-stars like you. You should be working on your business rather than in your business so that the company can stand on its own.
Business Exit Reasons
If you find yourself in one or more of the following scenarios, you should consider exiting the business.
If you have been able to rapidly grow your business to a point where there is broad acceptance of its success, you may be ready to accept public investors for your business via an IPO. Typically, you need a large and diversified user or customer base, a stellar team, growing revenues, and profitable financials to achieve this stage although the last requirement is often ignored in high-growth industries such as technology.
In the US, you will generally need $10 million in pre-tax earnings over the last three years, at least $2 million of which should have been earned in each of the last two years. For a more precise breakdown of the financial requirements of an IPO, read this. The stock exchanges also offer alternative requirements based on metrics such as market cap and revenue for large companies that do not meet the profit conditions.
Since an IPO involves considerable effort and expense, you should only consider it when you have achieved a scale that will justify these costs. A successful IPO can provide a very good exit strategy for the entrepreneur who wants to end his involvement with the business.
Sometimes, owners of successful businesses decide to cash out because of uncertainty about future market developments.
If you are selling in the luxury segment, in times of financial crisis, your target consumer might have less disposable income to spend on your products. Sometimes, changes in business regulations or government policies can adversely affect a business. In another case, a competitor enters the market and threatens your business model. Following Uber’s disruption of the taxi market, particularly in the USA, many owners of traditional taxi businesses have looked for a way to exit.
In each of these situations, it may make sense for the entrepreneur to pre-emptively plan and exit the business.
If you continue losing money after having tried a variety of approaches to stabilize the business, it may sometimes be best to call it quits. Quitting might be a wise decision if you are several years into your venture and still have no traction; customers still respond to your sales pitch with a blank stare.
You can read some informative anecdotes about failing businesses here. Continued operations may result in additional losses which will further erode your net worth.
BOREDOM WITH ROUTINE
Many entrepreneurs go into business because they are unhappy with the routine nature of a 9 to 5 job. If you’re this type of entrepreneur, you are motivated by novelty, by exciting new fields, by striking out on your own and doing something different every day.
If your company reaches the point where the business model is proven and it is simply an operational challenge, this personality type is likely to become restless and bored. After all, you started your business to do something exciting, not to create your own day job!
Consider selling up and rediscovering your spark in a new field. You might even have a new business idea of your own, devised while your current corporation was growing.
Many entrepreneurs deal with financial uncertainty, deals falling through with investors or customers, and constantly changing business models. The more innovative the business idea, the less likely the average person is going to relate to you; feelings of loneliness are not uncommon. These are conditions that take a long-term toll on mental health.
A study by Dr Michael Freeman, clinical professor of psychiatry at the University of California and an entrepreneur, found that 49% of entrepreneurs have mental health problems. The most common of these is depression (30%), while 27% have anxiety. Stress is a major contributory factor to both of these illnesses, and some entrepreneurs choose to exit their companies to avoid burning out completely.
Perhaps your business doesn’t suit your present lifestyle anymore. There could be several reasons:
- You may have reached a certain financial success and want to enjoy the rest of your life.
- You may have started a family and want to spend time with them instead of working 60-hour weeks.
- You may have acquired a new hobby, or rediscovered an old one.
- Lastly, as you start to slow down physically, it’s understandable that you would want to sell your business to spend your energy on your family rather than work all the time.
Business Exit Strategies
In general, the following five strategies are available for an entrepreneur to exit a business.
When businesses issue their shares to the public via a listing on the stock exchange for the first time, this is known as an initial public offering, or IPO for short. It is an exit in the sense that institutional investors (such as VC and PE investors) are likely to see a return on investment through improved equity values, rather than in the sense that the founders will end their involvement with the company. But after an IPO, the entrepreneur has the ability to sell his equity to the public and can thereby exit the business. IPOs used to be the preferred mode of exit, but the IPO rate has been in decline since the Internet bubble burst in 2000.
While IPOs are fairly rare compared to the number of startups that are created every year, the benefits of access to public capital in terms of prestige and financial reward can be staggering. Companies going public generally receive a lot of media attention; founder stock can be worth 8 or 9 figures. Indeed, it’s hard to become a billionaire unless you own a public company.
Unfortunately, IPOs are only possible if the company is successful at a large scale. Moreover, IPOs are expensive; typical cost over $1,000,000. Investment bankers can charge a significant amount in underwriting fees, and there are additional costs associated with complying with accounting and reporting regulations.
After going public, you can expect to be subjected to constant public and media scrutiny, as well as pressure from public shareholders looking for a short-term profit to increase earnings. Since public stockholders are more easily swayed by emotion than institutional investors, you can also expect share price volatility in the event of a recession or a downturn in your company’s business.
MERGER OR ACQUISITION
A very good option of exiting a business is to merge or get acquired by another company.
Mergers of companies with complementary capabilities bring economies of scale to the newly-formed business. Look for a capitalized acquirer who can close deals fast and on professional terms. In an acquisition, the entrepreneur’s equity will be taken over by the acquirer thereby providing him with an exit.
You should be wary of running your company with the aim of being acquired by one specific company. If your planned acquirer is not interested, you risk building a product so specialized that no other businesses will buy you either.
SALE TO A FRIENDLY BUYER
Instead of selling to an unknown competitor, sometimes it makes more sense to pass the business on to friends, family, employees or managers that you know well. Such a friendly sale is also a good exit strategy for the entrepreneur.
When you sell to someone you know and trust, that extra familiarity and trust translates into less due diligence on both sides, reducing legal fees for everyone involved. If you are selling to management who have been involved in the business, the transition challenges will be minimal.
On the other hand, leaving your business to multiple children without proper planning can precipitate nasty legal fights over ownership that can create dysfunction and tear families apart. If you sell to a friend and disputes later arise, you risk damaging the friendship. Alternatively, if you sell to managers who are also your friends, it is easy to focus so much on the friendship between you that you don’t negotiate as high a sale price as you otherwise would have done.
RETIRE WITHOUT SELLING THE BUSINESS
Sometimes, it may be possible to pass on the management of a business without selling it outright. In this instance, you remain as a shareholder, allowing you to benefit from its dividends without actively running day-to-day operations.
The main benefit of this approach is that you will continue to receive regular payments for little or no work. If you are retiring, this can be a nice complement to your lifestyle. If you are younger and still have entrepreneurial ambitions, you can use these funds to start a new business.
For this exit strategy to succeed, you need to have a trustworthy team and standardized systems and processes so that your business can continue to run without your day-to-day involvement.
A business is said to be liquidated when it shuts down, closes its doors and sells any remaining assets. Any proceeds are divided among the shareholders after creditors are repaid.
If you are burnt out, itching to start another business immediately or want to retire as soon as possible, liquidation has the advantage of being extremely quick. There are no negotiations about equity or expensive conversations with lawyers. Since liquidation is final, there’s also no need to worry about how trustworthy your buyer is.
On the other hand, liquidation is the least rewarding exit option in financial terms, as it nets you the market value of your company’s assets and nothing more. Intangibles such as client lists, reputation and business relationships might be very valuable, so you will probably be leaving a lot on the table by not taking the trouble to find a buyer.
Rather than waiting until the issue confronts you in the face, think of your exit as a plan that should be formulated as part of your original business idea. By exiting intelligently, you can maximise financial return for shareholders and investors and leave your venture in the hands of people that you trust, giving you the financial means and the peace of mind to move onto the next phase of your life.
For general topics on how to plan and grow your startup, see our Startup Mentor section. For specific details of how to launch and manage your startup in Singapore, see our Launch in Singapore section.