What is an exit?
When a startup is sold, this is known as an exit. When a startup exits, the exit typically provides all shareholders the opportunity to exit their positions, (read: sell their shares).
Exits can have positive or negative outcomes for shareholders. Ideally, founders and early investors will sell their investment position in the business at a profit, but sometimes these shares will be sold at a loss.
Thinking about possible exit options and outcomes in the early stages of a startup is laying the foundation for a positive outcome for further down the line.
A positive exit could be a significant sum of money for founders, and is how many founders make the largest portion of their income, given early stage founder salaries. Having a positive exit is generally supported by three pillars: maximum profit, minimal loss, and, hopefully, the success of the business is ensured after the exit of early founders and investors.
A positive exit for founders may be selling the business to another business at a higher valuation than what the business has previously been valued at, or listing on the public markets through a successful IPO (Initial Public Offering), again at a higher valuation than the business has historically been valued at.
There are less positive forms of exits, which in many cases, are a last resort, or a reflection that the business is struggling. This could be a quick fire sale M&A transaction (merger and acquisition), where shares are sold at a low price, at a loss for investors, if a business is in trouble.
It is important to have a thorough understanding of your exit options and how you can prepare for them, no matter what stage your business is in. Many investors will be interested in what founders see as potential exit routes when they choose to invest, and you are more likely to have a smooth exit if you have already considered the process that may be right for the business early on.
What are your exit options as a startup founder?
Mergers & Acquisitions (M&A)
A merger or acquisition (grouped term, M&A) is the most common outcome for startups. Why? Many companies choose to grow their offering by acquiring smaller businesses, and listing on public markets is highly complex, and only appropriate for businesses of sufficient growth trajectory or size.
Businesses choose to acquire other businesses for many reasons, including: to access and own IP, to expand into new territories, to gain a competitive advantage, to grow product offerings, to acquire customers, to acquire a high performing team, and on and on. Every acquisition will have different motivations and goals attached.
As a founder, M&A can be an appealing option because they can finally liquidate their shares into cash. Most start-up founders have invested a significant amount of time and money into their business, and usually take a lower salary for the business to grow and succeed. Therefore, an exit can compensate the founder for the time and money they’ve already invested in previous years. An M&A transaction can also provide a founder with an opportunity to be part of a larger group – they may remain employed by the company underneath the new owners, but with a wider range of resources to be able to explore new ideas and innovations.
Merging two companies to create a joint organisation or a company acquiring the other are, technically, two separate options, but over time, as they have been used so often in conjunction with one another, it has become known as an M&A.
Some of the most notable examples of successful M&A transactions for our portfolio companies are Cushon’s acquisition by Natwest and OfficeRnD’s recent partnership with Blue Star Innovation Partners.
Cushon’s investors received a 5x return on their investment, with Seedrs distributing just under £7m, whilst OfficeRnD saw a 60x return for their investors – one of the highest in our history.
In February 2023, NatWest Group agreed to acquire 85% of Cushon for £144m, with 15% retained by Cushon management. Cushon’s primary products are its workplace pension and range of workplace ISAs, including Junior ISAs, Lifetime ISAs and General Investment Accounts. Consequently, this acquisition gave Natwest a suite of tech-enabled financial wellness products to offer its commercial clients and their clients’ employees.
It’s often a good idea to be thinking about your sale value as your business grows – being aware of the biggest players in your industry, and what they would gain if they were to acquire your company, can be a contributing factor to the success of your exit.
However, with this in mind, an M&A exit doesn’t always equate to large success (and a significant amount of money). Sometimes, if the business isn’t doing as well as hoped or predicted, portions of the business will be sold off separately, or the company will be acquired at a minimum profit, or even a loss.
This is where there are typically two types of M&A: share sale and asset sale. A share sale is where the entire business is sold to a buyer – they would now own all the shares in the business and be the new owner. An asset sale is where the strongest or key parts of the business would be sold off but shareholders would keep their shares.
IPO/Public Listing
An initial public offering (IPO), is where your business is listed on a stock exchange for public market investors to buy shares in. Founders or early investors may need to sell some of their shares in order to issue more shares for the public to buy. This type of exit is significantly rarer in comparison to M&As as businesses typically need to be of a significant size and notably successful in order to be listed – think Visa, Facebook and Uber.
These transactions are also more rare than M&A as they are significantly more complex – and more expensive. The business typically will need to appoint an Advisory Firm to underwrite the public shares then market the business to public market investors on a roadshow, to fill the IPO allocation ahead of the public listing. Public companies have to adhere to much stricter regulatory and reporting requirements, so there will need to be significant internal preparations also.
As a founder, listing on the public markets can be an appealing option because it widens access to investment and visibility. It also can provide liquidity to shareholders as shares are now freely tradeable on the public market, rather than on the secondary market. However, it is good to keep in mind that not all public markets are born equal: small markets such as Aquis don’t provide as much liquidity as larger markets, such as the London Stock Exchange, or AIM. This form of exit can also have a consequence of better company image. Once the company is listed on a public market, the company will have to become a PLC (Public Listed Company), which means that it will be subject to stricter forms of regulatory requirements and may seem more trustworthy to clients, suppliers, and other market suppliers.
However, listing your company on the public stock exchange gains extensive media attention – and a lot of paperwork. Now that it is under heavier regulation, it will also come under heavy scrutiny, whether this is from shareholders, new stakeholders, and compliance, as it is now more vulnerable to both external and internal risk.
Secondaries
Secondaries are secondary transactions: when existing shares are sold by one shareholder to another party. This could be to an existing investor looking to increase their stake, or if you allow it, a new investor.
This is becoming more and more common as private companies are staying private longer, and investors may need to liquidate their shares before the company is ready for exit. This applies to both individual and institutional investors: Venture Capital funds typically have a fixed timeline within which they need to provide returns to their investors, so secondaries are a way of funds exiting investments without pressuring founders into a full exit early.
Being able to sell their shares to another investor at a point in the company’s growth timeline means that investors can see a return on investment quicker than waiting for a full exit.
However, it isn’t just investors that have been known to sell their shares though secondaries – founders have done it too. It isn’t a typical exit route as founders rarely, if ever, sell all of their shares, and it definitely isn’t for every founder or business, but it can be a way for founders to cash in on their businesses’ success ahead of a formal exit. You may choose to sell a portion of your shares, liquidising some of your assets and releasing cash flow, which would enable you to focus on the future of your company without worrying about your short-term finances.
The Cheeky Panda founders, who had several raises on Seedrs between 2017 and 2022, sold 3% of the company on The Seedrs Secondary Market to gain more personal financial stability without sacrificing a large portion of control to an institutional investor. They weren’t interested in selling to P&G or Unilever and had a long term goal of getting to the public market, but needed to free up some cash to give themselves financial security in the meantime.
How can you prepare?
Preparing for an exit is an extensive process and isn’t going to happen overnight. Once you’ve cemented your understanding of the potential exit routes available to you, considering the pros and cons of each option, the next step is to think about the framework you need to put in place to ensure the best possible outcome.
A great tip from First Round Review is to consider your perspective on the potential sale. You’ve probably identified who you think would be interested in buying your company, and this can feel daunting – how are you going to convince them to buy you out? Instead of thinking about your exit in this way, reframe the question to how am I going to get them to see that we are the perfect solution to X problem they have? This is the most important question that you need to answer, as M&A is not just a solution for the startup, but for the buyer too.
Other good questions to ask yourself as a founder preparing for exit mostly focus around getting your financials in order. Getting tax advice on what you are going to use the cash for, and considering the creation of charity and family investment companies can be a useful tool when working out what is best for you and the business. Getting corporate advice can also give a valuable second opinion on what is going well, what isn’t, and how to make sure the company doesn’t have any skeletons in the closet when it starts due diligence with a buyer.
Key Takeaways
Start preparing for your exit earlier rather than later. The sooner you consider all of your options, and work out with your co-founders or advisors which ones might work best for you and the business, the more likely it is that you will have a successful exit.
Consult an advisor to get your financials ready: conduct a thorough due diligence and don’t shy away from working out the right option in terms of tax. Selling a business can incur significant tax liability, so always consult your tax advisor when planning your exit.
