How to Choose an Exit Strategy
The most successful exits require considerable planning. The sooner you start, the more rewarding your eventual exit is likely to be. In fact, you already may have started planning without even realizing it. Many of the steps involved -- including creating an independent board, upgrading financial reporting systems and controls, exploring growth through internal operations, and fine-tuning your company's strategy -- are the same ones required to build a successful company.
"Most entrepreneurs over time should start to think about a future exit strategy because preparing for an exit takes some time," says C.J. Fitzgerald, managing director of Summit Partners, a growth equity firm with offices in Boston, Palo Alto, and London. The range of exit strategies includes taking the company public through an initial public offering (IPO), selling the company to a strategic acquirer, or recapitalizing and selling the firm to the management team, also known as a management buyout. "Most of those options take some forethought and preparation," Fitzgerald says. "Management should be thinking about what their end goal is and is the best way to get there for the company, its shareholders, and its employees."
This guide outlines the factors you should consider as you choose an exit strategy for your business -- and how to decide whether an IPO, an acquisition, or a management buyout works best for you.
How to Choose an Exist Strategy: A Look at Your Options
Before you can choose your exit strategy, it is important to understand the basic characteristics of each option.
- An IPO – In an IPO, you sell a portion of your company in the public markets. You and your management team typically remain in place for a period of years, your investors and managers may be able to sell some stock, and your company continues to operate much as it has in the past. However, your company will be subject to additional regulations, such as Sarbanes-Oxley requirements, and Wall Street analysts and institutional investors will scrutinize your quarterly performance. "There are companies that have the scale and growth necessary for a public offering, but the management team simply doesn't want to deal with the rigors of being a public company," Fitzgerald says.
- A strategic acquisition – In a strategic acquisition, another company purchases your business, either with cash or stock in the acquiring company or with some combination of stock and cash. The acquirer may or may not retain you and your management team, and may or may not make substantial changes in your company's operations, staff, and business lines. "The benefit is typically liquidity because if you sell the company to a strategic acquirer you might be able to sell most or all of your stock," Fitzgerald says. The disadvantage of this exit strategy is that "you are likely to lose operating control," he adds. "The management team may have run the company for a long time and enjoyed the freedom of controlling day-to-day operations. Selling the company to a strategic acquirer probably means they'll give that up."
- Management buyout – If you decide to recapitalize and sell the company to the next generation of managers it is known as a management buyout. This type of transaction is usually financed through some combination of debt and/or private equity investment, with the debt collateralized by the assets of the company. It provides immediate liquidity to the owner and early shareholders, and allows the company to continue as a private enterprise. "The benefit," Fitzgerald says, "is that you usually have a smoother transition." The founders most likely are not managing the company on a day-to-day basis, ceding that to the management team, which is now buying the company. This exit strategy marks a change of ownership, gets the shareholders some liquidity, yet provides a seamless transition for the company and employees and other constituencies.
Dig Deeper: Norm Brodsky on Exit Strategies
How to Choose an Exit Strategy: Considerations in Choosing an Exit
Different people start companies for different reasons, and that can influence their exit strategy. "Some people want to change the world when they start a company," says Eric Young, general partner with Canaan Partners, a global venture capital firm that has invested in more than 250 companies over the past two decades. "Some people don't want to work for anyone else. They want to stay small for perpetuity."
The right exit strategy depends a lot on the objectives of the people who own the business. Initially, the founder(s) own 100 percent of the business. If they take on investment over time from venture capitalists, angel investors, equity investors, or individuals, they usually give up a portion of the company, or shares, and those shareholders will have a say in any potential exit strategy.
The following are some of the things to consider when choosing an exit strategy:
Consider your future role in the business. Part of your decision will depend on whether or not you want to continue to manage your business. In an IPO or a management buyout, you and your team will play much the same roles before and after the transaction. In a strategic acquisition, however, the acquirer may replace you and your team with its own people. A strategic acquisition can be an excellent solution for companies that are struggling with succession-planning issues, while an IPO or a management buyout will work more effectively for teams that want to stay in charge.
Evaluate your liquidity needs. Many business owners view their exit strategy as a chance to reap the benefits of their hard work and to increase their personal liquidity. However, not all exit strategies work equally well in this respect. In an IPO, for instance, your shares likely will be subject to a share lock-up agreement, which means you will not be able to sell your shares -- even after the IPO -- for a period of time, typically six months. A strategic acquisition will often generate an immediate cash payment, thereby increasing owner liquidity. Sometimes, however, the final price is not determined until the end of an earn-out period, which can last several years. In a management buyout, the original owners also generally will receive liquidity over a period of time.
If you accept outside investment, you essentially take on partners, and those partners at some point are going to want liquidity. "When founders and entrepreneurs decide who to take money from it has a tremendous bearing on what the right exit strategy is," Young says. Entrepreneurs should look for good partners who don't pressure companies to sell or go public, but wait until the time is right for a liquidity event when the company has matured.
Think about your company's future potential. Perhaps you do not require immediate liquidity, but want to participate in your company's future growth potential. In this scenario, you will want to choose an exit strategy that allows you to retain an ownership interest. An IPO allows you to keep a substantial interest in the company, as well as to time the ultimate disposition of your shares to meet your own personal needs. A management buyout also will allow for continued participation in a company's growth. However, an acquisition will generally eliminate, or at least greatly reduce, your ownership interest in your company, as well as your ability to influence its future direction and performance.
Consider the impact of Sarbanes-Oxley. Taking a company public now entails meeting the costly, and somewhat bureaucratic, requirements of Sarbanes-Oxley. Many private companies begin working toward these standards early on -- establishing an independent board, arranging for an independent audit, and upgrading their systems and reporting to required levels. Meeting these standards not only will allow your company to go public, but also may increase its attractiveness to strategic buyers.
Assess market conditions. Demand for you company's products or services, the appetite for IPOs and acquisitions among both investors and strategic buyers, and other market conditions also will have an impact on your exit strategy. Talk with your private equity partner, as well as with any commercial lenders, investment bankers, or other financial professionals, about trends in the marketplace. The IPO market has swung back and forth since the dot-com boom in the late 1990s through the bust a few years later and on up to the most recent economic downturn, during which there were six venture capital-backed IPOs in 2008 and 12 in 2009 – compared with 86 in 2007, according to the Exit Poll report by Thomson Reuters and the National Venture Capital Association. But the number of venture-backed mergers and acquisitions didn't drop off nearly as much, with 348 in 2008 and 263 in 2009 compared with 378 in 2010, the report says. "I think good companies can go public at any time," Fitzgerald says. "Some just choose not to do so in tougher markets because their initial stock price will likely be lower. In those periods you either see companies waiting for the market to return or selling to a strategic or financial acquirer."
Consider a dual-track approach. Marketing your company to investors requires a slightly different approach than presenting to potential strategic buyers. Public market investors generally want to understand your company as a whole -- what your main businesses are, what your prospects for growth are -- while strategic buyers may be more interested in specific parts of your company that are complementary. Even though your pitch may be slightly different, you may wish to pursue both types of exits at the same time to capitalize on the most attractive opportunity. Summit Partners was an investor in GoldenGate Software, which was preparing for an IPO in 2009 when the company fielded an acquisition offer from Oracle. The company ultimately decided to sell rather than go public, Fitzgerald says.
Once you know whether your company will be attractive to institutional investors, or whether strategic buyers are actively looking for companies like yours, consider the steps listed above, as well as the price. Then consult with investors and senior managers so you can make the right decision for everyone involved: you, your company, your employees, and your customers.
Dig Deeper: How Much Is Your Business Worth?
National Venture Capital Association
For current market data on venture-backed IPOs and M&A transactions.
Exit Strategy Survey
A survey on current trends in exit strategies from the Tuck School of Business at Dartmouth College
Paper on IPOs vs. Acquisitions
"IPOs or Acquisitions? A Theory of the Choice of Exit Strategy by Entrepreneurs and Venture Capitalists," by Onur Bayar of the University of Texas at San Antonio and Thomas J. Chemmanur of Boston College, 2009.