What is an exit strategy?
Every founder and start-up business owner needs an exit strategy. An exit strategy is a plan for a person to exit a business. This usually happens when either it has reached a sufficient value for them to want to cash in their stake or the business is no longer profitable, and they want to end their involvement in the company. The goal of the exit strategy in the former case is to maximise profit and, in the latter, to limit losses.
Exit strategies aren’t just relevant to founders and business owners, but also to investors, traders and venture capitalists. Some exit strategies will relate to a single individual selling their stake in a venture, whilst other exit strategies may involve a whole founding or investing team exiting a business at the same time.
Selecting the right exit strategy for your business
Selecting the right exit strategy is a complex matter and depends on many factors. Seeking an independent business valuation and legal advice can help determine which strategy will be most suitable.
At Seven Legal, we specialise in providing start-ups, founders and entrepreneurs with stage specific legal advice. Our goal at exit is to help you exit on the best terms, whilst also looking after your employees and key stakeholders. We provide advice on common exits like mergers & acquisitions and management buy outs and buy ins. We can also help with reorganisations and restructures and buyer and seller due diligence. Find out more about our business exit services & packages.
7 types of exit strategy
- Initial Public Offering (IPO)
- Mergers and acquisitions (M&As)
- Management and employee buyouts (MBO)
- Selling to a partner or known investor (including family succession)
1. Initial public offering (IPO)
An IPO exit occurs when a private business ‘goes public’ by selling shares in the business. As a result the business transitions from being investor and founder backed to being part owned by public shareholders. After an IPO, the founder(s) and original investors can choose to sell their share in the business or stay on board. Even if the business owners ultimately decide to cash in it is likely that the founders and management team will stay on for a handover period.
- An IPO exit can raise significant capital and help the business to grow and expand.
- Founders & investors have the option to cash in their share in the business.
- IPO exits can be slow, costly and challenging to negotiate.
- There are high regulatory costs and significant reporting requirements.
- Founders and investors may be disappointed with stock performance.
- Increased scrutiny and pressure from shareholders, regulatory bodies and the public.
2. Mergers and acquisitions (M&As)
Mergers and acquisitions occur when a business is bought out or merged with an existing business. There are a number of reasons why a larger business may wish to acquire a smaller business, including;
- Eliminating a competitor;
- Expanding into a new geography or market; and
- Acquiring an asset (this could be a skilled workforce, company infrastructure or a desired product)
In a merger, it is likely that business owners will need to continue to be a part of the business and have a management role in the merged business. In an acquisition, the founders and owners of the smaller business will most likely give up their control and ownership of the business as it is assimilated into the new owning company.
- M&A can make for highly profitable exits. If selling to a competitor or multiple parties are involved in a competitive process, it is likely you can command a higher price.
- Founders and investors retain a high degree of control over the exit – including over the price and terms of sale.
- M&A can be time-consuming and costly and aren’t always seen through to completion – so you could invest considerable resources into a failed acquisition.
- M&A can lead to uncertainty for employees.
- Some acquisition exits may require the selling business’ founders and owners to sign an agreement that they will not work for, or start a new business, that would compete with the one just sold.
3. Management and employee buyouts (MBO)
Management and employee buyouts involve the sale of the business to the current management team or employees.
- Management and employee buyouts are often one of the quicker forms of exit to achieve,
- The owner of the business may retain a stake in the company.
- As the management team knows the business, this can minimise disruption for the business and employees.
- This form of exit relies upon there being sufficient interest (and personal funds) within the company’s management team or employees to achieve a sale.
4. Selling to a partner or known investor (including family succession)
This exit relates to a sale to someone that is probably already known to the seller (a ‘friendly buyer’). The buyer may be an existing partner in the business, an investor, a family member, friend, customer or colleague.
- It’s likely that the buyer will be known to the business and work to ensure minimal disruption and the continued success of the business.
- Like management buyouts, this exit depends upon you having a willing buyer ready to step in.
- The downside of a ‘friendly buyer’ is that as the seller you may feel conflicted or compromised in what you can ask for the business and end up taking a below-market price.
- Business and family/friendships don’t always blend well and you will need to consider the risk of personal fallouts.
Family succession (or legacy exit) is a common form of this type of exit. It occurs when an owning family member wants to pass down their share in a successful family business to a sibling, child or other relative.
The pros and cons when family are involved follow those for other types of sale to friendly buyers, but are likely to be heightened. The family member is likely to have a very good understanding of the business and can be prepped to transition into the role of owner for years in advance. However, the likelihood of underselling your stake in the business and the risk or personal relationships being affected can increase where family are concerned. It could also be the case that there is not a suitable or willing family member to take on the business.
An acquihire is a form of exit where the acquisition is based upon the value of your company’s employees. The buying company is motivated by a desire to acquire a skilled workforce and so works best in sectors with highly skilled and talented employees.
- Acquihires can be lucrative. Talented staff are highly valued and if you have a body of trained, loyal employees, this is appealing to prospective purchasing businesses.
- The acquihire model can help protect jobs in the business. As the staff are considered the main asset, retention of employees is likely to be high.
- An acquihire exit can be difficult to find a buyer for.
- Like other forms of acquisition they can be costly to set up and execute.
Unfortunately, not all ventures are successful. Where a business is performing poorly or failing to make a profit, a different kind of exit strategy is required. Liquidation involves the sell off of assets (property, infrastructure, equipment etc) to settle debts and pay off shareholders. Liquidation isn’t a desirable end point for a business, and so it is usually considered after other more favourable exit strategies have been exhausted.
- Liquidation can be relatively quick as a means of ending a business, without the long lead-times of an acquisition or merger.
- Whilst not a desirable ending to a venture, liquidation has a finality to it.
- Liquidation is likely to be a low-value exit strategy compared to alternatives.
- The business venture is ended and this has implications for employees, partners and customers.
- Potential reputational damage for founders and investors from the liquidation of the business.
The least desirable form of exit is undoubtedly a declaration of bankruptcy. For many founders, declaring bankruptcy would be considered a last resort.
- Following a declaration of bankruptcy by a business, you are no longer responsible for that business’ debts. However, any assets are seized to settle debts.
- There is a strong possibility that not all debts will be paid off by the assets seized.
- Like liquidation, there are implications for employees, partners and customers from a declaration of bankruptcy.
- Likely reputational damage for founders and investors.
- Business owners’ credit rating is likely to be affected.
3 quick tips on preparing for exit
Plan for exit from the beginning – From the moment you start a new venture, you should always have your exit in mind. Review your ability to exit at every round – you don’t want to find yourself (personally or as a business) tied in and unable to sell. Discover the business benefits of early exit planning in our blog post Don’t miss your exit.
Be clear on your exit criteria – From financial goals to the level of ongoing involvement you want in a business after exit, it’s important to be clear on what you want from exit and what might be the trigger point for starting the exit process.
Get ahead on due diligence – You never know when a great opportunity will come along. For that reason, you should always be ready to sell. Make sure you’re ready for potential acquisitions and exits by getting ahead on due diligence.
Manage internal operations with a due diligence questionnaire or checklist and by setting up a due diligence room (an online space where you maintain all documents that will be relevant to a sale, acquisition or merger). For more information and to access our data room guide with example filing structure and documents to include, check out our blog post: Due diligence for start-ups & how to set up a data room.
Get legal support on exit strategies
By offering stage-specific legal advice, we help founders and start-ups to negotiate every step of the business growth journey, including exits. If you have a legal question on exit strategies please get in touch with our lawyers today.