The Importance of Having a Startup Exit Strategy

When preparing a business plan, startup founders and executives should consider their exit plans. Whether business is booming or the startup is one of 90% of startups that fail, having a startup exit strategy in place is important, as it could help prevent the worst possible losses if the business is failing or it could help owners or investors get more profit when the business is successful.

But what is an exit strategy, and why is it important for startups and their investors?  

From IPOs to buyouts to bankruptcy, here’s what you should know about startup exit strategies.

Table of Contents

• What Is a Startup Exit Strategy?
• Importance of Having an Exit Strategy
• Exit Strategy Types for Startups
• Exit Strategy Types for Investors
• Plan for the Future With a Startup Exit Strategy

What Is a Startup Exit Strategy?

A startup exit is when an owner (and investors) of a startup company sells their ownership or stock in the company, either for profit or at a loss. A startup exit strategy is an overall plan by which the owner(s) guide the company to a profitable sale of their stock.

The startup business plan should include an exit strategy to prepare the business for the future, whether an owner plans to leave the company for retirement or to work on something else, a competitor is interested in buying out the company, an investor wants to sell and invest elsewhere, or any number of other potential events.  

Startup Exit Strategy Examples

There are many ways for startups and investors to plan an exit. Initial public offerings (IPOs) are one of the most popular and sought-after exit strategies and are typically considered a win for startups. Startups may also benefit from acquisitions or buyouts, which could bring a good profit for startup owners and their investors. 

On the other hand, startups that are failing may need to liquidate or declare bankruptcy to exit, but this often means financial losses and could impact owners’ chances of starting new companies in the future.

Importance of Having an Exit Strategy

There are two paths for a startup. The vast majority of startups will fail, leaving far fewer to go on to success. As such, founders must have a plan in place to either cash in on a successful business, either by leaving to join or start another company or to eventually retire, or to minimize losses by selling the company and its assets to pay off debts. 

For investors, having an exit strategy is important for getting the best ROI (return on investment) or to lose the least amount of money possible.

Prepares Businesses and Investors for the Future

Startups can expect many changes over the years. There could be an economic downturn, the business could run out of money, or a competitor could offer a big buyout or acquisition deal. Executives in the business could have personal matters that require them to step away from the company, or they could choose to retire. 

With a defined startup exit strategy for both positive and negative events, the company will have a clear plan to follow as changes happen. This can help keep the business running during volatile times.

Helps Determine Long-Term Goals

The exit strategy can serve as a long-term goal for the company, such as going public with an IPO. If founders want to leave the company, the exit strategy can help them determine timing and ideal prices they may consider for a future buyout or acquisition. If a startup is open to merging with other companies, they can consider mergers and acquisitions as part of their exit strategies and long-term goals.

Minimizes Losses

An exit strategy will be helpful if the startup runs out of money or doesn’t do as well as expected. The startup exit strategy can help get money back for the business, and that money can be used to pay off debts or redistribute to stakeholders in lieu of declaring bankruptcy.

Exit Strategy Types for Startups

There are multiple different startup exit strategies, and a new company may want to plan for multiple different positive and negative scenarios with varying strategies. 

For example, if the company is expanding and could use more funding to grow, an IPO could be a good fit. If the startup wants to prepare for potential loss in the future, they may create strategies for a buyout, an acquisition, or liquidation.

Initial Public Offering

An IPO is when the company decides to stop operating as a privately owned company and offer stock on any of the world’s public exchanges (e.g., NASDAQ is a popular exchange for tech IPOs). This is usually an attractive option for startups because it can bring in more money for the business. 

This process isn’t without its downsides, though. The IPO means control over the company is no longer in the hands of the founders; instead, company executives will need to operate in a way that keeps shareholders satisfied.

Buyout

A buyout happens when company leaders, third parties, or even friends or family members buy out the owner and take over the company. When company leaders take over, this is considered a management buyout, or MBO. A friendly buyout happens when friends or family of the owner take over. These strategies may work if the startup owners retire, become ill, or otherwise leave the business.

Startup owners may also decide to look for third-party buyers that can take over the company. This could be beneficial for owners who want to make money by selling the business and moving on to another job or retirement, but if the startup is experiencing losses, the negotiations could lead to less than desirable buyout offers.

Competitive Merger or Acquisition

Mergers and acquisitions (M&A) are another popular startup exit strategy. A merger is when a competitor and the startup join and become one new company. An acquisition is when a competitor purchases the startup and takes over it completely. Mergers and acquisitions may be a good fit for both startups and larger, long-standing companies. Acquisitions are actually becoming more popular for startups, with a 30% increase in tech-related M&A deals from 2020 to 2021.

Both options can help the founders gain money from the sale, and the startup founders may or may not still be involved with the business after a merger or acquisition. But it can also mean that a founder has less, if any, control over what was formerly their business.

Liquidation

Liquidation typically occurs when a startup is facing losses. The startup then sells its assets and uses the money to pay off its debts. Any leftover money is then given to the owners or those who have company stock. Although liquidation is usually associated with negative events for a startup, it is usually considered a preferable alternative to bankruptcy.

Bankruptcy

A startup may have to declare bankruptcy, which is a legal process that requires the business to surrender its assets in exchange for having its debts eliminated. Declaring bankruptcy can damage the credit for the founders, which could impact their ability to get funding for future business ventures.

Exit Strategy Types for Investors

Startup investors should also prepare exit strategies, particularly if the startup is not succeeding or meeting business goals. Having an exit strategy in place can protect investors from deeper losses.

Equity Stake Sale

Investors may exit through an equity stake sale, in which they sell their equity stakes to buyers. In exchange, the investor receives money for their equity stake and can move away from the startup. This may be beneficial for investors in successful or failing startups, as they can cash out when the equity stake is worth more to make more money, or they can negotiate a sale to minimize losses.

Time-Based Exit Strategy

A time-based exit strategy can help investors avoid worsening losses in their investments. The investor determines the amount of time that they are willing to go with investments that are staying the same or declining. If their shares don’t perform positively after the set amount of time, the investor can sell their shares.

Percentage-Based Exit Strategy

A percentage-based exit strategy can help investors secure a great profit when investments are peaking or minimize losses when valuations are dropping. The investor can set a strategy to sell when the company valuation is up or down by a certain percentage. 

However, the drawback for setting a percentage-based exit strategy is that the value can continue to change after the investor exits. For example, the investor may decide to sell when the valuation is up 100%. They’ll make a profit, but the valuation could continue soaring, and they’d miss out on the additional profits. 

On the other hand, an investor may decide to sell when the share declines 30%, but after the sale, the share could increase in value. The investor will have to determine what they are comfortable missing out on when setting their percentage-based exit strategy.

Plan for the Future With a Startup Exit Strategy

Owners and executives can come and go, and without a plan in place for their exits, the business may struggle with adapting to change. Startups should also plan for ways to pay debts when times are hard or minimize losses when the business shows signs of failure. When it comes to investors, an exit strategy will prevent the worst possible losses that come with risky startup investments.

 Discussing an exit strategy may feel uncomfortable for founders, but it’s an important and invaluable part of the business plan that shouldn’t be overlooked.