Exit-strategies for startups and investors
Exit in venture capital loans and financing of startups
In the venture capital sector, most investments are designed for an early exit of the investors from the company, depending on the concrete exit strategy. However, young entrepreneurs and investors should definitely think about these exit strategies before signing an investment contract, because it influences the decision for or against certain forms and conditions of the participation contract considerably. In the following we will inform you about the most important exit strategies.
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The meaning of the exit
In the field of venture capital (VC), investors always finance a project with an eye on the upcoming exit. The respective exit strategy is usually chosen before the conclusion of the VC investment agreements and is then defined in the agreements. A so-called "exit due diligence" can be performed to determine the optimal exit strategy for the respective project.
Which exit is aimed at decides on the one hand on the amount and form of the investment and the duration of the investment, but on the other hand also on the requirements for the owners and founders of the project and their rights in the investment contract.
Different forms of the exit
Basically, a distinction is made between the following strategies for exiting a company:
- Going Public / Initial Public Offering (IPO)
- Trade Sale
- Secondary Purchase
- Buy Back
- Management buy-out (MBO)
What is to be understood by it and which advantages and disadvantages the respective strategies have for investors and founders, is to be briefly presented in the following.
1. Going Public / Initial Public Offering (IPO)
Going Public or Initial Public Offering (IPO) is the process of taking a company public on the stock market. This exit strategy, known as the "silver bullet", is often the ideal and desired outcome of a VC investment. However, it is not an exit in the true sense of the word, but often only prepares for a subsequent sale of the company.
For investors, this path offers the greatest flexibility and the highest possible profit. They can profit from an increase in the value of the company by holding their shares for as long as they wish and are free to decide when to exit the company later by selling their shares.
But this path also offers enormous advantages for founders: Founders can raise the equity ratio in the course of the IPO. The company gains a broad ownership base, which strengthens the independence of the start-up from major investors with control and co-determination rights. In addition, all shareholders profit from their shares in an increase in value.
The company itself also gains recognition and prestige through the IPO. However, it requires additional financial outlay in the preparation phase as well as in the form of ongoing costs, for example for the now necessary regular annual general meeting and compliance with the new disclosure and accounting requirements.
2. Trade Sale
A trade sale involves investing in a start-up company in order to subsequently sell the stake in the company to another, larger company. This usually involves selling to a company from the same industry, which in this way purchases knowledge, patents and technologies from certain portfolio companies.
For investors, the subsequent sale promises a high profit margin without much financial or organizational effort, as would be the case with an IPO. The prerequisite is, however, that enough interested parties are found.
For founders, however, the trade sale involves considerable risks if they are not guaranteed the right to have a say. Because if they are not able to co-determine the buyer or the conditions of the sale, they risk losing their independence and influence from unknown third parties that are completely unpredictable for them. Therefore, the trade sale often results in the exit of the founders from the project.
3. Secondary Purchase
In a secondary purchase, the shares in the company are sold to another strategic financial investor. This investor usually has later financing phases in the focus of its investment strategy or can raise larger investment sums.
For investors this way is usually not very interesting, because only low returns are to be expected. For founders a loss of their independence threatens just as with a trade sale.
4. Buy Back
In a buy back, after the entry of investors, a buy-back of the investment by the founders or co-partners of the company takes place later.
In practice, this strategy is very rare. This is because it is rare that the shareholders taking up an investment have sufficient liquid funds to buy back the company after start-up financing and corresponding growth of the company. Their funds are regularly already tied up in the company.
Traditionally, investors and founders operate in an area of conflict: while the former are interested in the highest possible return, the founders are interested in the lowest possible purchase price. If there is no competition for the shares, the investors usually leave the company with a small profit. For founders, however, the buyback is the only way to regain full control over their company.
5. Management Buy-Out (MBO)
In a Management Buy-Out (MBO), the stake in a company is later purchased by the management and not by the owners of the start-up, as in a buy-back. If an external management team acquires the shares, this is referred to as a Management Buy-In. The advantages and disadvantages correspond to those of a buy back.
When a company is liquidated, it is dissolved and the proceeds distributed. As a rule, the dissolution of the company is not a voluntary goal of an investment, but happens in case of failure of a start-up. It comes to a complete termination of the project because a success is no longer conceivable or the investor terminates the investment contract.
For the investor, liquidation means the loss of the previously invested capital, which he then writes off. For the founders it regularly means the total loss of their enterprise due to the low liquidation mass.