An exit strategy has a two-fold purpose.
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First, the VC will pump in money into your ideas only if he sees a viable option to montetize his investment in the near future.
Second, for your own sake, it's always good to have the contingency plan – you never know when a product/service goes out of fad or when a better opportunity arises.
An exit option exhibits clear and long term thinking – you know your direction and you have the profit realization motive in mind. The prime factors to be taken into account for an exit strategy are the valuation of the business, the channel of exit and the time to exit.
An exit option should occupy a section of your initial business plan, right from the first VC pitch you make. A lot of VCs have explicitly said that they reject numerous business plans due to the missing 'exit route' section. Even if you have bought out a small business for further development, you should refine its concept document to include an exit option.
Mind that we are taking of non-public companies only. Public companies always have the exit option through the stock markets, and this is exactly what an exit option eventually tries to achieve.
With every encounter with the VC, you will receive new insights which should go into the refining of your exit option. Even as you do business, markets will change, regulations will change and competitors will change – all of these should reflect through a periodic appraisal of your exit plan.
Let us take a look at the commonly available exit routes -
- Acquisition. In acquisition, the acquiring company buys out the stakes of the target company and pays out the value in cash. Since the price offered during acquisition is based on the market value of the business and assets, the entrepreneur can have a controlled strategy to achieve the same. Hence this is the most common 'planned exit route'. It's like you start an email service called 'Hotmail', gear it up to the maximum value, and then sell if off to Microsoft for a clean profit.
- Sale of shares. This is the game that the serial entrepreneur is up to. They put in all the effort to bring up the valuation of a company and then make a sale of their shares to a willing buyer. Once they have realized the return on investment on their investment, they have free cash to explore new opportunities.
- IPO. Going public is the most desired, but least common way to encash the business. First, the road to achieving the size and organization structure needed to go public is very hard. Second, releasing an IPO costs a lot and requires a lot of regulatory compliance. If you allow me the exaggeration, an IPO comes once in a Google (googol = 10^100). Yet, getting listed on the NYSE is the dream of most entrepreneurs. Once listed, the original investors can sell off their shares in the market to realize the profits.
- Merger. A merger is the unification of two similar business to increase sales, product range, geographic reach or simply to expand in the threat of a larger competition. The entrepreneur can stay in the merged company, while the VC can give up his stake and move on. Generally in mergers, the value of the merged company is paid in terms of shares of the newly formed company. So, realizing the cash out of such a deal would require some time.
- Spin off. There could be a part of your business that is doing particularly well or that has become highly valued owing to emerging market opportunities. While that subsidiary is not important to your long term growth, some other company might be quoting high to buy off that business. In such a case you could divest that business through a spin off.
- Liquidation. Liquidation isn't a exit route, it's an escape route. You have decided that you just can't go on with the business any further or done so bad that it would not be possible to recover. You sell off the assets at market price; first pay the creditors and then divide the remaining among the shareholders. Liquidation can be a quick retirement policy too.
Besides these, there are others ways to quit, like, selling to a family member, letting the business dry off, selling to employees, etc, which can hardly be qualified as strategies. While mergers and IPOs are planned strategies, others opportunities emerge due to market movements and can hardly be planned. To make sure you get the best value for the business, you should keep your eyes peeled for business 'triggers'.
Whatever be the situation, as an entrepreneur you should have a strong exit strategy ready to start with.
Heed Stephen R Covey's words from The Seven Habits of Highly Effective People - "Begin with the end in mind".