By David Drake
Exit strategies take on different forms, but it is important that your startup should put one in place for your investors. While they are rooting and supporting your business, they are also looking for a return on their investment.
As an angel investor and venture capitalist, I have invested in several dozen companies over the last few years.
Here are some exit strategies that are most important for me:
- Initial Public Offer
Startups, you can do initial public offers (IPO) where you sell a part of your business to the public in the form of shares. This strategy offers more benefits in the sense that it enhances access to liquidity for you in the event that investors are seeking returns or refunds earlier than anticipated. Most importantly, it offers you a chance to buy out other companies that are also privately held and trading, and have reached a financial roadblock.
Aside from providing an exit strategy by being able to reimburse investors within your own startup, it can be a secondary form of exit for other investors across other companies by taking part in a buy-out. I have been involved in quite a few of these roll-ups where a company that is ready to go public buys up other smaller players as a strategy.
Another important and often considered exit is a merger. It is necessary for your startup company to exercise the option to merge with another company should cash flow or liquidity become an issue. All investors want to know whether they can get their money back should the deal go south. By ensuring your startup stays afloat will provide a certain level of security among your investors. I always want to know whether the startups I invest in know that they can sell the company in a merger acquisition.
3. Private Offerings
Startups, you can conduct a private offering of your shares to individuals or a select group of investors to raise funds. The offerings need not be registered with the SEC, and are exempt from required reporting arrangements and allows for existing shareholders to be bought out in a new fundraiser round.
Private offerings are less expensive and need less time to conduct since the services of underwriters or brokers are less required. You can choose investors who exhibit similar goals and interests, offering these investors more complex and confidential transactions. If these investors are entrepreneurs themselves, they can help in the company’s management.
Online leaders are firms automating this mode of business, such as AngelList, CrowdValley, SeedInvest, Crowdfunder, Fundable, OfferBoard and CircleUp, that use private offerings, taking advantage of the Securities and Exchange Commission’s (SEC) Regulation 506D exemption. This regulation allows companies to raise an unlimited sum of money from the public, but on the condition that the investors are accredited (have a net worth of $1 million exclusive of residence or have $200,000 in salary or $300,000 for married couples) and that these investors are sophisticated (have intimate knowledge of the market to be able to navigate the proceedings sufficiently and be able to mitigate any associated risks). They can solicit the public or advertise these offerings under Regulation D, 506c.
In real estate, the firms leading the crowdfunding industry front are Prodigy Network, Fundrise, Wealth Migrate, Real Crowd, Groundfloor, Groundbreaker, RealInvest, Realty Mogul, Sharestates, Patch of Land, to mention a few.
4. Cash Cow
Cash cows are firms that are able to command a high market share in an industry dominated by low growth. They are able to sustain enough capital to stay afloat for the foreseeable future as they promise years of increased profits. These startups are least likely to exit and will be more able to keep paying dividends to their investors and shareholders.
They will not want to exit, but rather cash in on their products, thus the term ‘cash cow’.
Instead of an exit strategy, these startups will aim for upping sales. They will keep paying dividends to their investors and other shareholders. However, should any investor feel the need to cash out, then these companies are highly likely to facilitate the request or make an even better offer to refinance these investors; potentially even structuring a management buy out.
5. Regulation A+
Regulation A+ is a skeleton version of an IPO. Today, this regulation allows you to put your startup company on an exchange after qualifying. You get to benefit from raising money and conforming to particular stipulations laid down by the Securities and Exchange Commission (SEC) without having to publish accounts publicly or file other mandatory paper works that would be required of an IPO.
Ben & Jerry’s ice cream is the most famous firm to have used this regulation in the past. They were able to do this by soliciting the public in raising money to finance their ice cream business. Since the passage of the Jumpstart our Business Startups or JOBS Act in 2012, and the subsequent rulings by the SEC making it legal to raise money from large groups of people on the internet, this regulation will catapult nationally 2016 as it quietly passed into law July 19, 2015. Initially, the money that could be raised was capped at $20 million, but the revised Regulation A law (which is now called Regulation A+) allows higher limits (of up to $50 million). Although you do need to have experienced lawyer, the cost is unfortunately still an issue. You still have to weigh the pros and cons of raising the funds against the actual costs involved in doing so, since the latter can be quite costly.
Startup, you can utilize Regulation A+ as a way of either introducing capital to the business or increasing it by ‘testing the waters’ (a phase initially employed for companies to gauge market responses to a new product or service before filing the $50,000+ cost to qualify under this law). I’m undergoing such a campaign currently.
6. Venture Capital
The key to maintaining a level of security among investors is to keep the cash rolling into the startup. Venture capitalists usually invest large sums of money into businesses and startups that are deemed worthy of note. Currently, there had been a downward trend of investments by venture capitalists due to the length of time it would normally take for investments to mature. Now, however, several venture capital firms, such as Canaan Partners and China-based firm Renren, are investing in crowdfunding platforms globally, which signals a shift not only in the capital structure of several startups but also on the goals and structures of the VC firms. These VC investments provide a steady source of cash to create more investments, expand development, and attract other wealthy investors who see the potential for high returns in the future.
Real estate crowdfunding companies are also going the venture capital route. I am tracking the top-performing realty crowdfunding companies in the world right now like Fundrise, Realty Mogul, Patch of Land, Sharestates, and Realty Shares among others at Timesrealtynews.com. Since the market is not yet as mature to capitalize on exits, these crowdfunding companies are instead pursuing the venture capital route as a primary source of growth and to gain the confidence of the crowd investors who may be less sophisticated. Having a sound VC backing provides the exit strategy that their online investors may be looking for.
As a startup, you need to have an exit strategy to enable your investors to cash in on their investments as well as to safeguard the value of your startup.
To sum it up, investors will want to know how they will get their money back from your business before they invest. In my real estate investments, I always want to know what my exit strategy will be. Often I ask myself, do I refinance to buy out investors and retain the property, or do I sell the property to recoup my investment? As a startup, you need to have an exit strategy to enable your investors to cash in on their investments as well as to safeguard the value of your startup.
Featured Image credit: VictoriaGlobal.co
David Drake is the Chairman of LDJ Capital, a multi-family office; Victoria Partners, a 300 family office network; LDJ Real Estate Group and Drake Hospitality Group; and The Soho Loft Media Group with divisions Victoria Global Communications, Times Impact Publications, and The Soho Loft Conferences. Reach him directly at David@LDJCapital.com.