Why Founders Should Care About Investor Exit Strategies

Why founders should care about investor exit strategies? Understanding their plans for an exit will help you plan the next steps to ensure the company’s stability and growth. Investors offer capital to companies with the objective to earn the maximum returns and exit at a reasonable time.

You’ll develop well-informed strategies for achieving the company’s milestones and plan future fundraising initiatives. Your investors’ exit plans will significantly impact your ability to attract capital from new VCs, angels, and private equity firms.

A well-defined exit plan is crucial for maximizing valuation and streamlining the transition when investors sell their shares. If executed strategically, the exit will translate into better returns for all the company’s stakeholders, including its founders. That’s the end goal you’re working toward.

From the founder’s perspective, having a handle on investor exit strategies is crucial if they have board seats. Their decisions can impact the future direction the company will take. This is why you should create open communication lines to manage expectations and prevent radical disruptions.

Let’s start by exploring the different exit strategies investors typically use.

Investor Exit Strategies

Investor exit strategies are carefully planned events where investors sell or liquidate their holdings in a company. They time their exit at reasonable times and under specific market conditions that will allow them to maximize their returns. Minimizing potential losses is also high on their list of priorities.

Investors may also have additional criteria, such as the optimum price points they hope to earn and preferred exit channels. For instance:

• Percentage exit: Investors exit the investment and sell their shares if the stock has appreciated or depreciated by a specific percentage of its purchase price. To cite an example, ABC Venture Capital may have a 300% return on investment (ROI) breakpoint. However, they may also have the rule to exit the investment if it loses up to 20% of its market value.
• The 1% rule: According to this rule, the maximum loss they will bear in a specific stock is equivalent to 1% of the investor’s liquid net worth. To cite an example, ABC Venture Capital has a liquid net worth of $3M. If an investment generates a loss of $30,000, which is 1% of $3M, they make an exit.
• Milestone exit: Investors may have pre-determined criteria for exiting the investment. To cite an example, ABC Venture Capital may sell its stock if the company fails to earn specific revenues within a fixed interval.
• Company’s valuation: Investors may time their exit to coincide with a pre-determined valuation figure. Thus, an exit strategy is a detailed roadmap for cashing out the investment.

Strategic Partnership Exit

Investors may push for the company to enter into a strategic partnership. Here, the partner eventually acquires your company. You’ll get assistance and direction with evaluating the partnership’s risks, downsides, and benefits.

Identifying partners to collaborate with and drawing up terms and conditions are other areas where investors provide direction. Of course, their recommendations are driven by the outcomes and profits they hope to generate–particularly after the acquisition happens.

From the founder’s perspective, you’ll evaluate if the partnership is a good move for the company. You’ll explore potential synergies and the complementary skills, market reach, technology, and capital contribution the partner brings to the table.

Most importantly, both collaborators should align their long-term vision and mission statements. Even as you explore the possibility of entering into the partnership, you’ll consider a potential dissolution. Also, be prepared to sell your company so investors can exit profitably.

If this is where you see the company’s future, you’ll fall in with the investors’ plans. However, an exit might not work for you if you plan on scaling the company and running further funding campaigns. This is why startup founders should care about investor exit strategies.

Secondary Market Sale of Stocks

Depending on their internal dynamics, investors may exit by selling their holdings to other private investors within the company. This strategy increases the number of shares and ownership stakes the buying investors have. Alternatively, investors may sell their stock in a secondary market.

In both cases, the buyers assuming ownership of the shares become shareholders. They are entitled to decision-making rights, and depending on the number of shares, their ownership stake can get much bigger.

Knowing your investor exit strategies, you’ll have a failsafe plan to ensure the company is stable. You’ll minimize the risk of disruptions in the company’s operations and leadership while lining up other funding sources. Also, you’ll institute measures to limit dilution and decision-making rights.

Lack of alignment with investors’ objectives, business acumen, and long-term goals can result in major disagreements. This could impact the direction in which the company progresses.

Entering into an M&A Deal

Instead of pushing for a strategic partnership, investors may use their voting rights to enter into an M&A deal. This deal could be with a competitor or a company dealing with complementary products and services.

You could be looking at a vertical or horizontal acquisition with bigger partners within the vertical. The deal may not impact your company’s profitability or stability, but it may not be your preferred direction. Integration challenges could result in the failure of the merger.

Management Buyout

A management buyout occurs when the company’s top executives and board of directors purchase the company from its owners. Investors may support the buyout by offering funding to the board to cover the company’s cost price. If that happens, it’s called a leveraged buyout.

Investor exit strategies like these may push company owners to accept the sale even though they are not ready. The company continues to operate as before and maintains stability thanks to the capital infusion. However, the founder loses control and may have to transfer control to board members.

Initial Public Offering (IPO)

Pushing to take the company public with an Initial Public Offering (IPO) is another strategy investors use. By listing the shares on the public stock exchange, they can liquidate them in the open market. Essentially, they allow public investors to purchase the shares.

However, investor exit strategies like these open the company, its operations, and its financials to public scrutiny. The company is now subject to regulatory obligations. A premature IPO can have major disadvantages for a small company, starting with the costs of running the IPO.

Reorganizing the company as a public entity is a time-consuming process that takes attention and bandwidth away from daily operations. Owners and management must redirect their efforts toward achieving short-term profitability and goals instead of long-term scalability.

Taking the company public also raises its weighted average cost of capital (WACC), which can be problematic. The management must account for this cost when executing expenses necessary to sustain the company’s growth. For instance, purchasing equipment, IP, or bigger facilities.

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Why Founders Should Care About Investor Exit Strategies

Aligning with Long-term or Short-term Growth

Seasonal fundraising consultants will advise you to partner with investors whose objectives align with the company’s. Ensure you have their buy-in with your vision and mission for the company. You need them to be on the same page when you make decisions about the partners you collaborate with.

Founders will also need their expertise and network support when not just raising further funding rounds. But also timing the raise strategically for maximum success. Most importantly, you’ll bring in investors who understand the vertical where you work.

For instance, you’ll need them to be patient and understand the time lapses between the completion of R&D and product launch. Accordingly, you’ll partner with investors prepared for extended exit plans.

Harnessing investor support and alignment with investor objectives ensures sound decision-making. You’ll need this coordination to create value in the company and ensure its sustained growth.

Investors planning long-term holdings will encourage you to build a sustainable market share. Their objective is higher returns because they detect potential in the company. However, investors looking at short-term exit plans may push for rapid growth and higher risks.

Their objectives are to make quick profits and exit their holding within a short time frame. This is why founders should care about investor exit strategies.

Company Valuation

Investor exit strategies can impact the company’s valuation every step of the way. Investors looking for short-term exit via an acquisition will trigger a lower valuation. Other investors will hesitate to invest in a company if they know the upcoming exit plan.

However, it’s advantageous if investors are in it for the long haul and interested in seeing it go to IPO. You’ll sustain higher valuations when running fundraising campaigns, optimizing financials, and gaining better operational efficiency.

Higher valuations translate into cheaper capital since you’ll be in a bargaining position and negotiate for favorable terms and conditions. If you intend to go for debt financing, expect cheaper interest rates and company-friendly repayment terms.

The company is better positioned to capture a bigger market share, demonstrates viability, and has higher employee morale. A higher valuation ultimately makes the well-timed IPO process much more streamlined.

Exploring your investors’ exit plans at the onset is always advantageous to ensure clarity in the funding process. Aside from exit strategies, you should know what questions entrepreneurs should ask investors. Check out this video in which I have explained what you need to know.

Having a Well-Designed Exit Strategy is Beneficial

Investors with a well-designed exit strategy see a clear pathway to recovering their money with rich returns. This raises their confidence in the company and its sustained potential. Exit plans also reassure other stakeholders since investors intend to maintain their holding for a fixed time.

This factor is encouraging for other investors, and when you start the next fundraising campaign, its success is ensured. Investor exit plans can also help you strategize your exit from the company.

Every founder should plan for their exit when building the company. Aligning your plans with the investors is a strategic move since it ensures a sense of direction. You’ll prepare for unexpected contingencies and leave out emotions when running operations or developing a succession plan.

The Takeaway!

Investors in the contemporary business ecosystem are more than just sources of capital. They are strategic partners that provide you with much more than just money. You can rely on them for their industry-specific expertise, valuable guidance, and network access.

Considering all these positives, you’ll select the right investors carefully after identifying entities that can add value to your company. More than that, you’ll also work out how to sustain the company if that support goes away.

This is why founders should stay on top of their investor exit strategies and be informed about their exit criteria. Knowing what to expect will help you plan the direction to take the company and the new investors to approach.

Chances are you’ll need a fresh segment of investors to match your company’s evolving needs. Side by side, you’ll also develop a founder exit strategy through a succession strategy or liquidation. You can also align your exit with investors to leave the company in more capable hands.

Careful planning eliminates unexpected situations and ensures the company’s long-term sustainability.

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