An Entrepreneur’s Guide to Exit Alternatives
A successful company’s lifespan is practically unlimited. On the other hand, an entrepreneur has a limited lifespan during which their goals and plans will almost certainly change. The business owner may want to meet new people, dedicate only specific tasks to themselves, plan a well-deserved retirement, or even found a new company.
But what will happen to the existing company?
Its continued existence requires a transfer into new hands, preferably someone who can handle the stress and challenges. Viewed from the outside, change in management and ownership is an entirely natural process that becomes part of the operational life cycle.
Early preparation for the inevitable change in leadership keeps the company in the market. It represents a significant challenge for both the owner and his future successor.
A Successful Exit
Many founders dream of it, but many do not make it. Whether, how, and when you should seriously consider an exit strategy depends on many factors. This article provides a brief overview of the most typical exit options: the IPO, trade sale, buyback, secondary purchase, and liquidation.
Let’s understand each of these a bit more.
1. Initial Public Offering
The ideal solution and usually the most popular exit option is an initial public offering (IPO). However, only very few start-ups manage such an exit in the end. In the event of an IPO, the shares in the start-up are offered on the stock exchange. A regular cash capital increase also results in new shares. Furthermore, existing shareholders often also sell part of their shares. Management contracts usually forbid managers from selling shares during this period (6-12 months).
2. Trade Sale
In a trade sale, the entrepreneur sells the stake in a start-up to a (usually) strategic buyer. The acquisition may occur as part of an asset deal, a share deal, a merger, or a share purchase. In addition to the IPO, the trade sale is now the most popular exit option. More details on this are below.
3. Secondary Purchase
As part of a secondary purchase, a venture capitalist (VC) investor sells their stake in the start-up to another financial investor at the end of the term of a VC fund. The buyer’s interest is mainly based on the regularly lower purchase price than in a trade sale and an assumption of lower risk because the start-up has existed for a longer time. This means the investor has more information about the business model and its previous development. The sale of individual start-ups or even the takeover of an entire portfolio can be interesting here.
4. Buyback by the Founders
Buyback (also known as buy-out) is the repurchase of a start-up by the founders. The founders buy back the shares from the investors (VC or an angel investor). This exit option is relatively rare and not very popular, as the founders often need a lot of capital.
Liquidation is the dissolution and closure of the start-up based on the shareholders’ resolution. The liquidation procedure is regulated by law and takes at least one year. Liquidation is a relatively rare and unpopular form of exit. At best, it is the â€œsilentâ€ alternative to bankruptcy.
What Exactly is Meant by a Trade Sale?
The context of a trade sale exit places strategic aspects in the foreground. The buyer is usually an entrepreneur and expects to profit by taking over the trade sale partner. From management’s point of view, the trade sale carries the risk of losing independence. However, apart from the IPO, the trade sale is a popular and desirable exit option.
1. Reasons for a Trade Sale
The decision to buy a start-up as part of the trade sale can be based on various reasons, such as geographical market expansion, access to new technologies and employees with unique know-how, product expansion (so-called horizontal expansion), or simply protecting one’s product from the competition. The preparation of every trade sale involves a precise analysis of the start-up and the benefits and burdens of such an acquisition.
2. The Trade Sale Process
If the start-up itself pushes the trade sale, a distinction is usually made between the following phases:
- Preparation phase: definition of a typical sales strategy, elimination of weak points in start-ups, and commissioning an M&A consultant, if necessary.
- Documentation: preparation of the due diligence review, and draft sales memorandum.
- Establishing contact: addressing potential buyers (competitors), and obtaining indicative offers/letters of intent.
- Negotiations/due diligence: due diligence review, draft, and negotiation of the company purchase agreement.
- Signing/closing: conclusion and execution of the purchase contract.
3. Participants in the Sales Process
The sales process often involves the following parties in addition to the buyer and seller:
- Banks: These institutions finance company acquisitions and, if necessary, replace the existing financing.
- Customers/suppliers: Since prior consultation with essential contractual partners is advisable, customers and suppliers should be involved in an asset deal.
- External consultants: Lawyers, tax consultants, and auditors are regularly commissioned as part of legal and tax structuring, implementation of the due diligence review, and preparation and negotiation of the contractual documents.
4. Basic Types of Trade Sales
There are two basic types of company sales: the share deal and the asset deal. In a share deal, the start-up is transferred through the transfer of the legal entity; i.e., the shares in the start-up are sold. In an asset deal, the start-up’s assets are transferred by way of individual legal succession. The legal entity itself is not shared. The transfer of personal legal interests (e.g., patents, software) is also possible.
Each of the various forms of exit strategies has its advantages and disadvantages. Nonetheless, from the seller’s point of view, the IPO (though highly unlikely for most middle-market businesses) and the trade sale usually remain the most promising exit forms. Regardless of the exit strategy you choose, it behooves you to think seriously about an exit strategy right from the start of your business.