How To Exit From Your Startup Investment
What is a Business Exit Strategy
A business exit strategy is a method used by investors such as venture capitalists and angel investors to receive a cash out of their investment. It gives them a way to reduce or liquidate stake in a business and if the business is successful make a substantial profit. It also helps to limit losses in case the business has not been successful. Some of the common exit strategies include initial public offerings (IPO), strategic acquisitions and management buyouts (MBO). The strategy chosen for exit would depend on numerous factors with each method offering its own advantages and disadvantages.
Common Exit Strategies
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1) Mergers and Acquisitions (M&A)
One of the most common exit strategies for startups with venture capital or angel investor funding is through M&A. In an M&A, a startup is bought or merged into a larger peer or competitor. It is a common occurrence and can take the form of large corporate buyouts such as in the case of Walmart’s acquisition of a 77% stake in Flipkart for USD 16 billion. It can also be used by relatively smaller companies to increase their efficiency by adding complementary businesses to their arsenal. Smaller companies may prefer to use marketplaces like SMERGERS to conduct M&A activities since it would provide shareholders with quicker liquidity at a lower cost than traditional M&A channels.
It is estimated that globally there were 6,948 deals in the first half of 2020. The value of these deals amounts to USD 901 billion. The financial services sector emerged as one of the top performers in this period with a market share of 17.1%. Within the sector, six of the largest transactions announced were investing or banking related and included Morgan Stanley’s USD 13 billion bid for ETrade Financial, Kuwait Finance House’s USD 9.8 billion offer for Ahli United Bank, and Franklin Resources USD 5.4 billion bid for Legg Mason.
This method is used significantly in India as well and it is estimated that the value of M&A deals in India was USD 38.1 billion in the first half of 2020. Most of the deal making activity involving India was mainly in the energy and power sector which was valued at USD 8.6 billion and captured a market share of 22.7%. Telecommunications and financials placed second and third with a market share of 15.5% and 14.65% market share, respectively.
2) Initial Public Offering (IPO)
An initial public offering (IPO) refers to the process of offering shares of a private corporation to the public in a new stock issuance. Public share issuance allows a company to raise capital from public investors. An IPO is often considered one of the most prestigious forms of exit as it is associated with high payoffs and status. A public offering is a rare form of exit that requires a lot of work and time. Due to the high liability concerns, shareholder demands and high costs, a public offering may not be feasible for most startups.
Globally, a total of USD 95 billion was raised through 445 IPOS in the September quarter of 2020. India was ranked ninth globally in terms of the number of IPOs year-to-date in 2020 and tenth with respect to capital mobilised, with a 1.4% market share. There were 8 companies in India that came out with IPOs in the third quarter of 2020. The value of the IPOs in these 3 months was estimated to be worth USD 850 million. Real estate, hospitality and construction were the most active sectors with 2 IPOs being launched in each sector. One of the largest IPOs in this period was an IPO by Mindspace Business Park REIT which had an issue size of USD 602 million.
China’s Shanghai Stock Exchange ranked first both in terms of number of issues and proceeds with 180 IPOs raising around USD 39.3 billion year to date in September 2020. USA’s NASDAQ was close behind with 119 IPOs issues that raised USD 34.1 billion dollars. The Chinese company Semiconductor Manufacturing International’s USD 7.5 billion IPO was the biggest during the quarter, however, the American company Snowflake also had a major IPO offering of USD 3.9 billion.
3) Management Buyout (MBO)
In an MBO, the management of the company buys purchases the assets and operations of the business they manage. This type of exit strategy is favoured by large corporations looking to sell individual divisions that are not part of their core business or by private businesses whose owners wish to retire. An MBO allows a company to go private in an effort to streamline its operations and improve profitability. Typically such buyouts are possible with the support of Private Equity firms or as Leveraged Buyouts where the management borrows a significant amount of capital for acquiring the firm.
Management buyouts are a rare occurrence in India, however, one of the more well-known cases of a management buyout in India would be in the instance of Capital First. In 2012, the MD of the NBFC, Future Capital effected a takeover of the company with an equity backing of USD 159 million from Warburg Pincus and renamed the company Capital First. The company has since merged with IDFC Bank to form IDFC First which has the distinction of being the first management buyout converted into a bank. One prime example of a management buyout is when Michael Dell, the founder of Dell, paid USD 25 billion as part of an MBO to take the company private and exert more control over its direction. The deal paid shareholders USD 13.88 in cash per share, making it the biggest buyout in years. The company has since gone public again through a share swap with its DVMT VMware software business tracking stock.
Other Alternative Exit Strategies
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1) Private Offerings or Secondary Sales
Private offerings allow shares to be offered to individuals or a select group of investors to raise funds. These types of offerings do not need to be registered with SEBI and are exempt from reporting arrangements.
Private offerings are less expensive and need less time to conduct since the services of underwriters or brokers are not required which is why they may be preferred by some firms. It also allows the offering to be made to investors who exhibit similar goals and interests, offering these investors more complex and confidential transactions.
2) Cash Cow
Cash cows are firms that can generate a steady cash flow for investors and pay an appropriate dividend through the years. This is typical with firms which command a high market share in an industry dominated by low growth. They can sustain enough capital to stay afloat for the foreseeable future as they promise years of increased profits.
When a company is positioned as a cash cow, they are highly likely to facilitate an investor’s need to cash out and may even make a better offer to refinance these investors potentially structuring a management buyout.
3) Asset Liquidation or Write-Offs
It is widely believed that more than 99% of startups fail and in such cases, the only recourse for investors is to write off such investments, liquidate any assets held by the startup and recoup its salvage value. In this method, the assets of the business are liquidated, and the funds acquired are used to cash out investors. This is not usually a recommended strategy as it used mainly in distressed situations where the business can no longer continue to function.
The value of the physical assets would also be heavily discounted if the company is in dire situations and intangible assets like brand name and business relationships may be damaged or lost. However, it allows a business to offset the loss in its operations and they may make use of online platforms such as SMERGERS to liquidate their business assets to acquire some return on investment.
Conclusion
Venture Capitalists rely on exit strategies to get a return on their startup investments, which have a high risk but also have a chance to give back high returns. For example, Masayoshi Son, Softbank’s founder is currently among the wealthiest people in Japan because he was able to utilize the company’s majority share in Alibaba to gain liquidity during the latter’s IPO offering. In 2000, SoftBank had invested USD 20 million for a 34% of Alibaba under Masayoshi Son’s decision. Just 4 years later Alibaba sold USD 22 billion of stock in what was the biggest IPO on record reaching a market cap of USD 231 billion with Softbank’s stake being valued at over USD 60 billion.
Another well-known case of VC funding would be in the case of Google. In 1999, Google raised USD 12.5 million each from VC firms, Kleiner Perkins and Sequoia Capital. A few years later in 2004, those investors stakes in Google were worth almost USD 4.3 billion each, which was a return of 300 times on their investment.
The best exit strategy would depend on numerous factors such as business type and size. The objective of the exit would also play an important part in choosing an appropriate strategy. In the case of multiple shareholders, the interests of each party must be factored into the choice of an exit strategy as well. Exit strategies may take many different forms but it is important to have one in place to capitalize on investment and ensure profitability.
References
1) https://www.investopedia.com/terms/e/exitstrategy.asp
2) https://m51.co/blog/exit-strategies-for-venture-capital-funds-a-peek-behind-the-scenes/
3) https://www.alleywatch.com/2020/05/startup-exit-strategies/
4) https://imaa-institute.org/m-and-a-statistics-countries/
6) https://www.alleywatch.com/2020/05/startup-exit-strategies/
7) https://www.investopedia.com/terms/i/ipo.asp
9) https://www.investopedia.com/terms/m/mbo.asp
11) https://www.huffpost.com/entry/six-startup-exit-strategies_b_8254780
14) https://www.mergermarket.com/info/mergermarket-releases-1h20-global-ma-report
15) https://www.cbinsights.com/research/best-venture-capital-investments/#Ali
