Exit Strategies For Tech Entrepreneurs: Knowing When And How To Sell

Investopedia defines a business exit strategy as “a plan that a founder or owner of a business makes to sell their company, or share in a company, to other investors or other firms.” Startups are often created with the intention of being sold once they have achieved their profit targets. At this point, an exit strategy can be an initial public offering (IPO), an acquisition, or a buyout.

An exit strategy is often developed at an early stage and outlined in a business plan so that investors understand how they will receive a return on their investment. Apart from the possibility of cashing out, founders and investors may plan an exit strategy to minimize loss in the event of an unprofitable business or a sudden change in market conditions or personal circumstances.

Whatever the reason, it is essential to have an exit strategy as early as possible but also to be flexible and prepared to adjust your initial plans if circumstances change. Once you have decided on the strategy, you can focus on the tactics to exit on more advantageous terms. To maximize your chances of success, it is important to outline desired outcomes, set timelines, and equip yourself with tools to effectively navigate the exit process.

The world of digital entrepreneurship is often described as volatile, meaning that a technology company operates in a highly turbulent and competitive environment where new technologies are constantly emerging and challenging the existing ones. As a result, the valuation of the company is prone to significant fluctuations. A delay caused by a lack of planning can result in a deal being closed on less favorable terms.

Let's now look at some exit strategies along with challenges and benefits related to each.

Exit Strategies

1. IPO (Initial Public Offering)

An IPO is an event in which a privately held company issues new shares and makes them available to the public for the first time. This process is a way of raising funds to finance further expansion of a company or its business needs such as research and development or debt reduction.

However, an IPO can also be an exit strategy for early investors, founders, and shareholders of a private firm. When the company lists its shares on a public stock exchange, the existing shareholders get an opportunity to sell their shares to the public too. The share price is set based on firm value and market conditions, but it also factors in early investors’ needs and objectives. It is an opportunity for them to get profit from their initial investment.

According to John Vinturella, Suzanne Erickson Raising Entrepreneurial Capital (Second Edition), 2013, IPO is the most lucrative exit strategy, as it allows for liquidity, and generally, greater company valuations can be achieved to the benefit of venture capitalists. They have a chance to win through an IPO more than with most other exit strategies. Of course, if the share value at IPO and market conditions are favorable.

The challenges associated with this strategy are public scrutiny and the financial disclosures required to comply with the requirements of the Securities and Exchange Commission (SEC).

In addition, an IPO can lead to a dilution of control over a company. In a public company, the entrepreneur becomes accountable to many shareholders. Unlike early investors, they may not share management's vision and deep understanding of the business. Furthermore, decision-making becomes more cumbersome as the company's post-IPO operations have to be negotiated with many.

However, the risk of exposing your company to the will of random people can be avoided by creating different classes of shares with different rights for shareholders. This allows an entrepreneur to keep more control in the hands of the founders and seed investors.

Other motives are possible for an IPO. For instance, during his interview with the Financial Times, Pavel Durov stated that for Telegram, an IPO is a way to remain independent and give users a chance to own part of the company.

2. Selling a Company

While IPO is the canonical motif in startup success narratives, the reality is much more prosaic: a private firm is much more likely to be acquired than to go public. “In 2018, for example, 85 venture-backed companies went public, whereas 799, or nearly ten times as many, were acquired, according to the National Venture Capital Association.”

When considering this strategy, it is important to understand that there are two ways in which the business can be sold, either in whole or in part. The first option is for the owner to transfer ownership and liabilities by selling the shares to a buyer. In this case, the buyer takes over the business in its entirety, together with its assets and liabilities.

An alternative is an asset sale. In this scenario, an owner sells certain assets while retaining certain liabilities. This can be a solution for an original owner to obtain liquidity to pay off liabilities, if any. In a digital product company, intellectual property rights are not rarely the most valuable asset. Potential buyers or investors may seek to buy out only a particular technology.

This is an option for a small software company to monetize on their Intellectual property.

The advantage of selling a successful startup unfolds even more when several competitors enter into a bidding war to acquire a company. In the course of negotiations, the initial company's value increases, and founders may exit the business with a great return on their investments.

Small tech companies with a unique product or technology are a tidbit for bigger firms. They are seen as an asset that enhances and strengthens the company’s offering. For instance, a two-and-a-half-year-old Helios has recently been acquired by Snyk, a cyber-security unicorn. Because the buyer and the seller complement each other, this has become a win-win story (according to press releases of the companies).

For Helios, becoming a part of Snyk meant gaining access to the ideal platform that allows them to bring their “technology and product to a wide array of AppSec and development teams”. Snyk says that with the acquisition of Helios, they will enrich their developer security platform.

The major drawback of acquisitions is connected with the fact that the business is being sold to an external buyer. This may adversely affect the continuity of the business, lead to restructuring, disrupt the company’s culture, and result in the loss of customers.

Apart from commercial and financial considerations, the personal circumstances of founders and employees are at stake. For the sake of your reputation and the welfare of your employees, choose the buyer who shares your values and vision for the company's post-acquisition life.

3. Management Buyout (MBO)

Management buyout happens when a management team member buys out a controlling interest from the current owner and gains control over the business. The current owner withdraws from the operations while getting benefits from the transactions such as cash, continuity of the business, perseverance of the company’s values, and privacy.

This type of exit process is the least disruptive for customers, suppliers, and employees. Firstly, it would be hard to find someone who knows your business better than your senior management. Therefore, by selling the controlling stake to them, you can eliminate the potential negative impact of the learning curve on business processes.

Secondly, the deal can be completed in less time because it involves less paperwork, you can avoid due diligence checks and keep the terms of the deal private. Finally, if your managers' values and vision are aligned with yours, you will have some peace of mind about the legacy of your business after the acquisition.

There are challenges to this strategy. Buying a company requires substantial capital, and the chances of finding a buyer with adequate financial resources within the company are lower than outside. There is also the risk of a conflict of interest and disagreement over the fair value of the business. As a result, instead of finding a good buyer, you may lose a good manager.

4. Bankruptcy/Liquidation

When negative scenarios unfold, the founders are forced to close a loss-making business by selling its assets and inventory to pay off its liabilities. The remaining liquidity is distributed to shareholders. This strategy is generally seen as the last, least valuable exit option. Any takeover bid at this point is a better solution than liquidation.

Conclusion

While there is no one-size-fits-all formula for exit, there is some data and research that outline trends. For example, the authors of this research, after considering firm-specific characteristics for 1,074 IPO and 735 sellout firms, suggest that the transition to public ownership via IPO is the choice of firms with greater growth opportunities that face more capital constraints.

In any case, to find a strategy that fits your goals, surround yourself with qualified advisers and lawyers who would help you make the right decision and who would guide you throughout the process.

Whatever strategy you choose, the process should begin with a clear understanding of your business's value and market conditions. Next, it is important to remember that potential buyers will be interested in a thorough review of your business from a financial, legal, and business perspective. This means that your business must be transparent and all financial records must be in order.

Both an acquisition and an IPO involve financial disclosure, compliance, and reporting requirements. While the management buyout is less complicated in terms of paperwork, these deals are not free from compliance requirements.

Given all the above, try to start planning your exit well in advance, at least 3-5 years before the target date. The more time you have to implement operational or structural changes to maximize the value of a business, the more chances you have of achieving your goal.