Exit Strategy Planning — How Will You Get Your Money Back?
The main incentive for investing into a startup is to make money. There are different ways an investor can cash out, which depend on the chosen exit strategy. Investing into a startup, always think about the possible exits beforehand and see if it seems possible to actually get a return on the investment. The exit strategy plan for the startup should come as first consideration.
Always keep in mind that not all startups make an exit and many fails before they even have a chance to do so.
There are different ways an investor can cash out their investment and potentially make a profit. One way to do so is when a startup has an exit. The startup has to have a liquidation event meaning the business is sold to someone else or goes public.
An investor can have an exit without the startup exiting. They can do so by getting rid of their stake in the company and making either a profit or a loss on their initial investment.
There are two ways a startup can make an exit?—?mergers and acquisitions, and an IPO.
Mergers and Acquisitions
Mergers and acquisitions are the most common ways for a startup to exit. Although they are often used together, there is a difference.
A merger refers to a deal where two existing companies merge together under a new business entity. The startup ceases to exist and becomes a part of the newly formed company. The reason for mergers is usually to join forces to explore new segments or markets, or to gain market share.
An acquisition takes place when another company buys the startup or obtains the majority stake in it. The startup then will either cease to exist and be consumed by the buying company or will keep their current business as it is just with different shareholders. An example of an acquisition is Instagram which was acquired by Facebook.
What this means to you as an investor is that during the buying process, depending on the shares you own in the company, you will get the respective amount of funds from the merger/acquisition process.
Initial Public Offering
Initial public offering or an IPO is often referred to as ‘going public’ or ‘getting listed’. It means that the startup will list on a stock exchange and becomes publicly tradable. Startups will usually do an IPO to raise more capital or to liquidise the investments of the early investors who invested into the startup before they went public. An example of a startup who did an IPO is Snap Inc (Snapchat) listing on the New York Stock Exchange. This means that the investor is able to sell their shares in case they would like to cash out.
An investor can exit without the startup exiting through a private offering.
Investors can sell their shares to other investors privately hence the name private offerings. It is different from a public offering due to the offering of shares to a small number of investors. Such offerings are often less expensive and less time-consuming than IPOs.
An investor can also profit without an exit when the startup has matured and starts paying dividends to its investors.
The company begins paying dividends
Not all startups will go public or be merged/acquired. Some startups who are able to sustain their business and create profits might not be interested in the exits mentioned above. Instead, they pay their investors dividends that come out of the profits the startup makes. For an investor, this means you will be cashing in on your investment most likely over a period of time depending on the amount of dividends you will get. Should an investor need to cash out completely, they are most likely able to sell their shares to another investor through a private offering.
Profit or a loss?
As mentioned earlier, find out the exit strategy the startup has, if they have one, and see how that fits into the plan regarding the invested money. As an investor you are not guaranteed to get back your initial investment, the money you receive is depending on the valuation the startup was sold at. If the valuation was less during the exit than what it was when you invested in it, you will be faced with a loss.
Never invest more capital than you are willing to lose.