Startups looking for angel investors or venture capital (VC) absolutely need an exit strategy because investors require it. The exit is what gives them a return.
Exit strategies related to startup funding are quite often misunderstood: The “exit” in exit strategy is for the money, not the startup founders or small business owners. The company brings in money and the investors get money out. So startups looking for angel investors or venture capital (VC) absolutely need an exit strategy because investors require it. The exit is what gives them a return. And the rest of us, starting, running, and growing a business, but not looking for outside investors, will probably need an exit eventually; but there’s probably no rush.
The exit strategy related to startup funding, is what happens when investors who had previously put money in a startup get money back, usually years later, for a lot more money than they initially spent.
Investor exits normally happen in only two ways: Either the startup gets acquired by a bigger company, for enough money to give the investors a return , or the startup grows and prospers enough to eventually register for selling shares of stock to the buying public over a public stock market, as happened with Facebook in 2012 and Twitter in 2013.
The traditional exit strategy
When investors sit for pitches from startups, they expect the startups to cover the exit strategy. That usually means talking, in the pitch and in the business plan, about how similar companies in similar markets have been able to exit via selling out to a larger company. The more sophisticated plans and pitches will mention recent exits and offer information about how the companies that exited were valued when they were bought. That usually ends up as something like “[this similar company] was purchased by [that company] in [that year] for [that amount], which was [that multiple] of its revenues.” The standard phrase in that context is “5X” for an exit value of five times revenues, or “10X,” or whatever. And that should not be confused with similar phrasing describing the investors’ exit: an exit at “5X,” for example, would be one in which the investors received an actual exit amount, in money or shares they can sell, of five times what they originally invested.
You can understand how investors feel about exit strategy if you consider what happens to investors who don’t get exits. They don’t have a return. They put money into a company, but they get nothing back. Having a minority share in a healthy, growing company, without any prospect of an exit, is a terrible scenario for investors. My own angel investment activities include more than one investment in companies that are still healthy, still growing, still have happy founders, but no good prospects for exits in the foreseeable future. And that scenario, while it can be very good for the founders, is terrible for the investors.
A different type of exit strategy
Aside from the investor-oriented exit strategy, which is a factor in every outside investment, you’ll occasionally hear about a different kind of exit, when the startup founders, the entrepreneurs themselves, sell their company and turn their ownership in a business into money. This happens most often as people get older and want to finish their careers. More rarely, you’ll encounter younger entrepreneurs whose vision from the start was to establish a business, grow it fast to make it attractive to a purchaser, and sell. These are also exits.
Do you know how to write and pitch an effective exit strategy? Do you have any questions? Share with us in the comments below.