Exit Strategies, a brief exploration

A startup exit strategy is an entrepreneur’s strategic plan to sell a company’s ownership to investors or another company. An exit strategy provides a way to lessen or liquidate an entrepreneur’s stake in a startup and, if the startup is successful, earn a substantial profit. If the business is not successful, an exit strategy (or “exit plan”) allows the entrepreneur to minimize losses.

The selection of exit strategies for startups is a vital decision to be made by entrepreneurs and investors and is one that plagues the startup ecosystem of the world today. The importance of deciding an exit strategy lies in the fact that such a decision will affect fundamental aspects of a startup’s operation, such as business development decisions and the startup’s future. Various startups plan their exit strategies at different points during their operation. Most startups, however, develop their exit strategy in their original business plan. The two most common and preferred exit strategies adopted are Initial Public Offerings (IPO) and Mergers and Acquisitions (M&A). IPOs are usually regarded as the holy grail of exit strategies as they often come with great prestige and the highest payoffs. We should note, however, that there’s no one infallible strategy to be adopted as the decision made among these alternatives depends on a broad assortment of situational factors. Having understood what exit strategies are, let’s examine these strategies individually to discern their various merits and demerits.

Initial Public Offerings (IPOs)

Image displaying IPO

An initial public offering (IPO) marks the exit point of a private startup. It is the system of selling the shares of a private enterprise to the public in a new stock issuance. Public share issuance empowers a startup to acquire capital from public investors. Typically, this stage of development happens when a startup has attained a private valuation of about $1 billion, also known as unicorn status. However, private startups at different valuations with solid fundamentals and verified profitability potential can also qualify for an IPO, depending on their ability to meet up with listing requirements and market competition.

Merits of filing Initial Public Offerings (IPO)

Better access to funds

The most often mentioned reward of an initial public offering is the accompanied massive capital. The proceeds from filing for an IPO provide sufficient grounds for many startups to go public even without considering additional advantages. These funds can serve a developing startup in innumerable ways. Startups may use IPOs to minimize liability, employ new staff, finance research, and development, fund capital expenditure, erect buildings, obtain new technology or other companies, or bankroll any number of other possibilities. The funds raised by an IPO are significant and can enhance the growth trajectory of a startup.

Enhanced corporate image and credibility

IPOs provide exposure as it thrusts a startup into the public spotlight. Researchers all over the world report on every IPO to help their clients know whether to invest. Startups not only receive a great deal of attention when filing for IPO but also receive credibility. To complete the IPO filing, a startup must go through intense scrutiny to ensure only facts are reported. This scrutiny, combined with most people’s tendencies to trust public companies more, can lead to improved credibility for a startup.

The minimized total cost of capital

Filing for an IPO can significantly minimize the challenge of securing additional capital. Rigorous audits required of the IPO process results in increased confidence in the startup and ultimately results in lower interest rates on loans obtained from banks, as the startup is now known to be less risky. Asides from lower interest rates, a public business can raise additional funds through subsequent offerings on the stock exchange, which is often easier than obtaining capital through a private funding round.

Enhanced liquidity for investors

The opportunities realized from filing for IPO will inevitably lead to improved liquidity for investors since securities are traded through a public market. This greatly improves an investor’s ability to convert his or her shares quickly and conveniently into cash.

Demerits of filing Initial Public Offerings (IPO)

High costs

The comprehensive process of taking a private company public will require substantial funds to carry out. IPOs demand several fees including accounting, legal, printing, underwriting, and filing fees to mention a few.

Potential loss of control

A major disadvantage of filing an IPO is the potential loss of control by founders or entrepreneurs. Since filing for IPO means receiving money from shareholders, it is expected that the business operations should align with their best interests. Where there is a conflict of direction between the founder and shareholders, there is a chance the founder might be forced out of leadership through public criticism or shareholder votes.

Public disclosure and regulatory requirements

Another major disadvantage of filing for IPO is the exposure of vital corporate details about the company to the public. Such details may include corporate governance practices, executive compensation, financial results, and insider trading information among others. Going public also entails expensive and demanding regulatory obligations like a presentation of financial statements to the Securities and Exchange Commission (SEC) and audits from certified accounting firms.

Mergers and Acquisitions (M&A)

Image depicting M&A

Mergers and acquisitions is a common term that defines the union of startups or assets through different sorts of financial activities, such as acquisitions, mergers, tender offers, consolidations, management acquisitions, and procurement of assets.

Merits of mergers and acquisitions

 Improved market share

When startups unite, the new business obtains a larger market share and gets ahead in the competition.

Decreased cost of operations

Startups can realize economies of scale, such as bulk purchasing of raw materials, which can result in cost reductions. The investments in assets are now spread out over a larger output, which leads to technical economies.

Avoidance of replicated products

Some startups offering similar products may merge to bypass duplication and defeat competition. It also results in decreased prices for the customers.

Expansion opportunities

A startup attempting to expand its business in a specific geographical region may merge with another similar startup operating in the same location to get the business started.

Job security and prevention of bankruptcy

Mergers and acquisitions can save a startup from becoming bankrupt. This will also save many jobs, resulting in job security.

Demerits of mergers and acquisitions

Creation of unemployment

In a hostile merger, a startup may decide to drop the underperforming assets of the other startup and this may lead to loss of jobs for some employees.

Difficulty in communication

The startups that have decided to merge may have different values and cultures. Such differences may result in a communication gap and negatively impact the performance of the employees.

Elevated prices of products

Mergers and acquisitions result in decreased competition and a bigger market share. This may lead to a monopoly and an inevitable increase in the prices of a startup’s products or services.

Prevention of economies of scale

In situations where there is little in common between the startups, it may be challenging to obtain synergies. A larger startup may be incapable of motivating employees and achieve the same degree of control. Thus, the new company may not be able to achieve economies of scale.

Key factors to consider in deciding between IPO and M&A

  • Regulatory requirements and public scrutiny: Founders must be aware of their tolerance level and prepared for public attention and rigorous regulatory requirements from the SEC. If they are not on board with this level of scrutiny, an M&A is a more ideal choice.
  • Attachment to startup and products: Before making the vital selection between filing for IPO and entering into a merger and acquisition, founders must examine how attached they are to the startup and its product. Where they are deeply attached to the startup, an IPO is an ideal choice as there is a greater chance of retaining control in an IPO. It should, however, be noted that they may also negotiate continued employment or an advisory role in an M&A.
  • Additional venture to finance: In a case where founders have other ventures they wish to fund, a merger and acquisition is a more reliable and safer method of securing capital than filing for IPO.
  • Risk level evaluation: Startup founders must critically examine the risks associated with both exit strategies. An IPO is generally perceived to have more risks than an M&A, such as when the IPO does not generate as much buzz and revenue as predicted. Founders also have to assess what is owed to investors and make decisions based on the results.

For more extensive analysis and Market Intelligence reports feel free to approach us or visit our website: Venture Capital Market Intelligence Reports | VCBay.

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