Having an Exit Strategy in place when raising investment
Posted on 22/05/2019
What is an exit strategy?
From the outset, when an investor invests in your business they need to know how they will get a return on their investment and when this will happen. So, this is not necessarily your exit from the business, but when the investor can anticipate a return on their investment.
What does an exit look like?
There are three main ways that an investor can extract value from your business:
- Initial Public offering (or IPO),
- The sale of the company to another organisation, known as a trade sale,
- Or by returning part of the money you earn from customers, known as revenue distribution.
Here you sell your shares on a stock market, typically the Alternative Investment Market (AIM) in the UK, which is part of the London stock exchange. AIM is designed for smaller companies. It costs around £250K to £500K and takes around 3 to 6 months to float on AIM.
In a trade sale you sell your company to another organisation. It could be another company who is buying you for your assets, the customers, the technology, or it could be an investment fund that is buying you as part of their investment methodology.
This is a specialised exit, and tends to be used for things like film production, but is very rarely used for product and consultancy companies. In this approach you share part of your return with your investors. It might be a percentage of revenue, or more likely a percentage of profit.
If and when you receive investment from family and friends, many early stage companies use dividends to return value. Revenue distribution tends not to be liked by the VCs, as they need to convert all their assets to cash at the end of the fund life.
Of course, at an early stage of the business, thinking about your exit strategy is difficult. Knowing when to exit is a tough choice and each situation is different. However, based on today’s assumptions, you put forward your most likely scenario. And guess what, tomorrow those assumptions might change, but you have thought about them and can defend your initial assumptions. Be confident and remain flexible.
Sometimes, trying to predict an exit is a leap too far. Concentrate on explaining how you will break the mould and be a great disruptor. Although honestly, very few things are truly disruptive, so this approach should be used sparingly as it opens up as many questions as it answers.
Only a few investors will be happy with the approach “build a big community and worry about the value extraction later” – you can use this as a plan, but expect to be challenged upon it. Explain how your customer base will quickly grow and why they are valuable customers.
Sources of inspiration
When considering exit options, take a look at companies similar to yourself at a later stage in their growth journey. What was their exit strategy and what was the company valued at? This information used to be really difficult to find; however, subscription services such as Beauhurst are useful to find these examples. Equally, speak to other entrepreneurs and your professional advisors like your accountant, lawyer and IP agent for what information they might have.
Your investors are likely to be selling their shares to someone else to generate wealth for themselves. You need to provide a scenario that helps investors understand the options that your company might have in the future. This is different than the company being profitable. It is about how they can make a return on their money.