From seed to harvest: exit strategies for startup founders and angel investors

The world of startups is all about dreams, innovation, and building the future. But let’s not be coy – it is also about returns on investment. Both the founders and the angel investors hope that there comes a time to reap the rewards of all their hard work and dedication – a successful exit. Let’s find out, when is a good time to exit, what strategies can be used, and how to know what is the best option.

Exit: why you need a plan 

An “exit” is an event or strategy through which founders, investors, or shareholders ‘cash out’ their investment – in other words, liquidate their ownership in the company into tangible assets like cash or other securities. The timing and method of the exit can vary significantly and depend on the specific goals and circumstances of the parties involved.

An “exit strategy” is a plan on how and when the stakeholders of a company intend to or have an opportunity to exit their investment. Exit strategies give founders, early investors, and other stakeholders a roadmap to their financial goals. Planning out your exit strategy early on can make all the difference due to a combination of financial, strategic, and personal factors that are at play. Also, exit strategies should align with the goals of both founders and investors and should be revisited and adjusted as the startup evolves.

The most common exit options for founders and angel investors

Two of the most sought-after exit options are an acquisition and an IPO. 

Acquisition is the most common exit strategy for both founders and angel investors. In this scenario, a larger company purchases the startup, founders receive compensation based on the acquisition terms (in cash, stock, or a combination of both) and angel investors also realize their returns. This option provides liquidity and gives the stakeholders a return on their investment.IPO (Initial Public Offering) means listing the company’s shares on a stock exchange, enabling founders and early investors to sell their shares to the public. It’s less common than an acquisition because it comes with substantial regulatory requirements and costs.

The choice between acquisition and IPO depends on various factors, including the company’s growth stage, market conditions, and the strategic goals of the founders and investors. For example, an acquisition is a lot simpler process than initiating a public offering. Also, the acquisition is usually more profitable for the stakeholders since the valuation for an IPO has to be a lot more conservative. There’s also the question of whether the founders want to exit the company fully (common for an acquisition) or just liquidate their hard work but keep working on the company (common for an IPO). An IPO, on the other hand, could be an opportunity to engage with a wider financial audience.

Secondary market on the rise

In recent years, the secondary market for startup investments has been on a continuous rise. A secondary sale means selling a portion of your equity to private buyers while founders remain in control of their company. It offers founders, key employees, and investors a shortcut to liquidity and a viable way to buy ownership in private companies for other investors. 

The key benefits of secondary transactions: 

Higher employee and stakeholder motivation. On average, it takes 7-10 years for a startup to reach an IPO or acquisition, if they even get there. This can be a long wait. Secondary deals offer employees, investors, and founders a way to monetize some of their equity before the final exit. An opportunity to clean up the cap table. We’ve talked about the importance of building a healthy cap table before. If you didn’t get off on the right foot, secondary transactions are a good way to shorten the list and buy out small investors ready to exit. A good way to navigate a rough fundraising climate. The secondary market became especially popular during the startup funding crunch. The first two options – acquisitions and IPO-s – were hard to come by, yet the demand for liquidity was on the rise. When the pressure for liquidity goes up the secondary market offers a welcome solution for all parties without the risk of a public downround.

When to exit: 8 factors to consider 

Timing – exiting too early may leave potential value on the table while waiting too long could be risky or inefficient.Valuation – aim for a valuation that reflects the company’s true potential and market conditions.Strategic fit – an exit should ideally complement the startup’s long-term goals and mission.Taxing – tax implications of various exit strategies can significantly impact the final earnings. It’s a good idea to consult with financial advisors. Legal and regulatory requirements – all exit strategies involve legal and regulatory processes, some more complex than others. Consult with specialists to make sure all relevant laws and regulations are followed.Investor agreements – make sure to review the terms in investor agreements, such as preferred stock provisions, which may impact the timing and terms of an exit.Team and culture – an exit can strongly affect the startup’s team and culture. Maintain open communication to mitigate any potential disruptions.Market conditions – in a rough economy, there are usually fewer exit options, and the terms are less attractive. Be prepared to adapt your strategy accordingly.

3 ways founders can avoid common exit pitfalls

To set the stage for a successful exit, founders need foresight and attention to detail. There are three key areas to cover. 

Plan early – the age-old saying, “Begin with the end in mind,” also holds true for exit strategies. Early planning enables founders to align the company’s growth trajectory, financials, and operations with the desired outcome. Founders have time and insight to mitigate risks and enhance the company’s overall attractiveness to potential acquirers or investors. Founders also have time to build relationships with key industry players, potential acquirers, or investors. This can significantly increase the likelihood of a successful exit. Align and manage expectations – the expectations of founders and investors should be in sync. It’s always a good idea to keep up transparent communication from the beginning and throughout the startup’s journey. All parties should openly communicate their long-term goals and expectations as well as exit expectations and return goals. Make sure these are outlined in the term sheet and investment agreement. Founders need to keep all parties informed about the company’s progress and challenges and make sure new investors are aligned with existing stakeholders. Consult experts – we can’t stress this enough, legal and financial advisors help maximize the value and minimize the risks, basically paying for themselves. Avoiding mistakes is a lot cheaper than solving them when you already face the consequences. Make sure that all contracts and agreements follow the regulatory requirements and protect the interests of both the founders and investors. Familiarize yourself with valuation, tax implications, and the structuring of deals. Expert guidance can also be crucial regarding the timing and approach of an exit.

To sum it all up 

In the world of startups, exit strategies are not an afterthought but an integral part of the story. Exit offers founders and angel investors the opportunity to realize their hard-earned gains and make way for new adventures. A carefully planned and well-executed exit strategy can turn your startup journey into a truly rewarding experience. And as usual, transparent communication and adaptability can take you a long way.