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Every smart entrepreneur wants to know that they will be getting something out of a new business venture, whether it be money, or the pleasure of seeing the business continue in a family succession or a sale to employees. Whatever the reason for starting a new business, the entrepreneur and her investors want the business venture to be successful so that they may see a return on investment (ROI).
Every new business venture needs to have an exit strategy. One of the reasons that many startups fail is because they lack an exit strategy. An effective exit strategy allows business owners to have a planned termination (or continuation, such as, in a family succession) of a business venture in a way, and at a time, that will maximize returns or limit business losses. The anticipation of returns is why smart entrepreneurs are willing to take the risk.
Successful companies mitigate their risk with a carefully planned exit strategy. Risk mitigation is the process of taking steps to reduce exposure to adverse effects, such as, business failure.
Reasons that may call for execution of an exit strategy include:
The most popular exit strategies are Initial Public Offering (IPO), Mergers and Acquisitions, and Closing.
Closing the business may be the best option if your business venture is failing, isn’t valuable enough for anyone to want to acquire it, or is the type of business that’s unlikely to be valuable without you personally doing all the work (such as, most consulting services). You will sell off the company assets (such as, inventory, fixtures and intellectual property), lay off workers, pay creditors and employees and shut down the business.
However, if you plan to close as an exit strategy, you will make sure to exit at a time when you can raise enough cash from an asset sale to pay all the company’s debts and pay wages. Otherwise, you may have to make formal or informal arrangements to pay off your creditors, file for voluntary liquidation, and declare bankruptcy, and/or be subject of litigation brought by your employees for non-payment of wages. Although the entrepreneur does not, in general, have individual responsibility for the business contracts, debts, and engagements, New York Law imposes personal liability on LLC members and corporate shareholders with the ten largest ownership interests or shares in the company for the failure of the company to pay employee wages.
you can plan to sell the business to qualified buyers, pay creditors and pay back investors. You can transfer ownership of the business to an individual (such as, a third party, partner or key employee) or another business in a merger or acquisition, consolidation, acqui-hire or management buyout.
The preparation for the M&A part of your exit strategy involves making sure that the company is saleable at the time, and you have assembled a team (of experienced advisors) that has the skills and experience to successfully execute the exit. The team must have the necessary knowledge, skills and experience in M&A, Corporate Law, Taxation, Financial Planning and Wealth Management.
Of course, exit timing is critical. Missing the optimum time to exit means that you may be settling for an exit valuation significantly below market, or not exiting at all.
To prepare the business for a sale means that you will ensure that the decisions you make will maximize the value of the company, and make it more attractive to the next owner. If you have something a buyer wants and can’t find elsewhere, such as a unique product or distribution channel, they may be willing to pay a premium price. In preparation, you will do anything that increases transparency, efficiency, revenue or profitability, or decreases risk or costs. These include:
Typically, a company chooses to go public when: (a) the company has achieved significant milestones, typically, in the form of sustainable profitability or solid revenue growth; (b) the company needs to raise a huge amount of additional growth capital via the public markets; (c) existing investors, founders, and employees are seeking liquidity: the ability to sell shares on the stock market (where the stock is easily traded).
To prepare for an IPO, the entrepreneur obtains the assistance of an external IPO team consisting of an underwriting firm, lawyers, certified public accountants (CPAs) and Securities and Exchange Commission (SEC) experts. The IPO team helps determine what type of security to issue, the best offering price, draft documents for the SEC, prepare Significant legal & disclosure documents, including, tax, financial or accounting information – to be provided to prospective shareholders – and files its prospectus with the SEC via a S-1 filing.
A company that is planning to go public usually starts to plan 12-18 months in advance. To go public, a company needs to be formed as a C corporation and have a valuation in the hundreds of millions.
An IPO is an expensive and lengthy process that involves considerable risk, and the company will need to be ready for the scrutiny and exposure that comes with being a publicly traded company.