Exit Planning for Software Start-Ups

Build an entrepreneurial family dynasty or look for an exit to become a serial entrepreneur? This decision faces founders who have built successful companies and kept them growing. Most entrepreneurs prefer the roll-up-your-sleeves challenge of working in startup roles. Hence, an exit at the right time is the only healthy option for the business and the owner. Besides, a startup with no exit strategy is more likely to minimize the investors’ returns.

If you consider the exit option, which exit strategies are suitable for start-ups, and what’s the best approach? This article shows the most popular options and explains what start-up owners should pay attention to.

Exit Planning Explained

Exit planning is a structured, detailed process that helps you define when you plan to exit your business, how you’ll exit your business, the proceeds you’ll need to do so, and the steps required to get there. An exit planning advisor usually leads the exit planning process, which ideally starts at least four to five years before an owner’s deadline to transition. Planning well in advance of an exit is especially critical for most businesses.

Reasons Why Companies Buy Start-ups?

In today’s market, the realistic exit scenario for most founders is selling the company to a strategic investor. Large companies take over small companies for various reasons, including expansion and increase in sales figures and turnover, increased profit, geographical development, and the acquisition of new sales channels.

Furthermore, large companies usually suffer from a lack of internal innovation. To solve that problem, they acquire new, exciting technologies with the associated solid and innovative teams to plug the “innovation holes” in the company’s product portfolio or to tackle new markets to restore the internal, entrepreneurial mood that previously made it successful.

Reasons Why You Need an Exit Plan

Founders should be aware of exit options sooner rather than later. Often, they cannot avoid it because every venture capitalist, from angel investors to venture capital funds, calculates their commitment with a medium-term termination, maybe five years. Therefore, they demand a reasonably convincing exit plan from company founders before investing a cent. Unless you finance your start-up entirely yourself (i.e., bootstrapping), there is no getting around a regularly revised exit strategy.

Start-up entrepreneurs who think about exit options early also grapple with making their companies even more attractive to investors and buyers. Only thinking about exiting when the company gets into difficulty does the business, its employees, suppliers, and customers a grave disservice-that failure to plan risks making the wrong exit strategy and selling the company far below its value.

Ideally, the entrepreneur and the investor should discuss the various exit scenarios before working together and agreeing on an option.

How Startup Owners Generally Exit

Initial public offering (IPO). Who doesn’t dream of entering the billionaire league with the IPO of their start-up? Jeff Bezos and Mark Zuckerberg did it with Amazon and Facebook. An IPO is conceivable. The initial public offering (IPO) is considered a silver bullet, as it usually brings higher returns than all other exit options.

ZoomInfo went public at a time when most U.S.-based tech companies refused to do so. The COVID-19 pandemic essentially put all tech IPOs on pause, but the IPO market picked up again with ZoomInfo. The company’s stock closed at 62 percent above its IPO price on its first day of trading. Another example of a well-prepared IPO is Vroom. Vroom was among the first IPOs over the summer to see its stock more than double on its first day of trading, reigniting the IPO versus direct listing discussion. The company closed out its first day of trading at $47.90, more than double the opening share price.

Sale to a private investor (private auction). This is recommended in an unfriendly stock market climate. Anyone who sells their startup to an investor, as Partpic and Amazon have done, can make a lot of money for themselves and the other shareholders. For example, at the age of 26, entrepreneur Jewel Burks Solomon successfully negotiated with Amazon to acquire her company. For best results, potential buyers should be identified in advance and relationships cultivated early, without neglecting the business operations. Company founders need to have a good plan to handle the sale and a clear range for sales revenue.

Secondary purchase. With this option, founders and investors go their separate ways after the sale. The shares of the previous investor are sold to another investor who expects a good return from further company growth. Successful start-ups that operate in a stable, secure market can also get a trustworthy governor into the company who takes over and is responsible for the business. The founders, therefore, remain owners and secure a steady source of income with their start-up cash cow. They can fall back on that income to realize the next business idea. The governor should be experienced and understand the business; after all, healthy cows have to be fed and cared for to continue to yield.

Buyback by the founders. In the case of a buyback, only the investor leaves the company, but not the founder. This happens when the founder buys back the investor’s shares. A buyback is a relatively rare exit option because founders need a lot of capital to invest in their start-ups.

Critical Steps to Exit Planning in a Start-up

1. Identify when you want to exit (be specific) and how you hope to exit. In the early phase of every start-up, founders should think about a possible exit strategy. This is not only demanded by potential financial investors. It also makes selling easier as soon as an opportunity arises. The founder is then responsible for keeping the company’s documents up to date. Scrambling to gather the necessary documents after receiving a prospective buyer’s request not only makes an unprofessional impression on the buyer but may also even lead to a reduction in valuing the start-up. These documents include the actual company key figures, a cap table, and accurate recordkeeping of intellectual property. In short, if you start, you should always keep an eye on the exit.
2. Establish baseline value. The assessment of the “right” company value depends mainly on how healthy the company is currently, what future value it represents, and what value it creates for the potential buyer (in his opinion). A generally solid corporate structure enhances company valuation. It is much better to let a competitive market determine the company’s value. Unlike personal financial tools or business accounting systems, baseline value accounts for your business and financial situation.
3. Avoid mistakes during execution. Selling a business is one of the most critical decisions in any business owner’s life. It is important to act with caution and to be aware of the following common mistakes. One is wanting to sell the company alone. You’re the expert in your business but likely lack the profound experience of a professional consultant who manages several exit processes every year. A good consultant streamlines the creation of a competitive situation between investors and thereby achieves an optimal exit value. The operational team, on the other hand, should concentrate on day-to-day business. Proper financial accounting should also always be a top priority. Disorganized, sloppy bookkeeping may pull down an assessment in due diligence.

Who Can Help You?

Like all other corporate processes, the exit process must be prepared and carried out professionally. Experienced advice from third parties is essential to negotiate a fair price for a company. Most firms work with a value creation consultant or exit planning advisor specializing in working with start-ups to develop their value creation strategies and plan for their eventual exit. Contact Quantive today to see how we can help.