Exit Strategies

For entrepreneurs, one of the most important concepts to understand is that of the “exit strategy.”  Having an exit strategy is most important when a company intends to take on additional equity investors, but even if you are starting or operating a business you intend to run until you retire, knowing how you intend to shut down (or transfer) the business is vital.  If you view the life of your business as being a story, the exit strategy is an ending, even if the company continues to operate afterward.  Knowing how you intend to end the story will improve your ability to get there.

In the coming weeks, I will post about some of the most common types of exit strategies and discuss what they are and some of the advantages & disadvantages of each.  For those not familiar with the concept, however, I want to discuss what one is in this post.  The vast majority of companies are privately held companies.  While there are advantages to this (e.g. not having to make regular filings with the SEC, ability to use unaudited financial information), there is a major disadvantage in that stock in the company is relatively illiquid.  Being illiquid means that the stock cannot easily be converted to cash.  First, there are often restrictions placed on the stock around its sale in any shareholders agreements.  Even if none exist, finding purchasers for stock in closely held corporations is not easy, and while it has become easier in recent years with the growth of secondary markets, in order to remain in compliance with securities regulations there are limits on who it can be sold to and the restrictions will mean that the stock is frequently sold at a discount to what it would otherwise be valued at. 

An exit strategy is the solution to this problem.  It lays out how the board and management intend to give equity investors an opportunity to sell their equity and realize the gains on their investment.  Exit strategies can take many forms including public offerings, sale to a large acquirer, and a stock buy-back.  As equity holders in the company, it also represents how the founders can hope to see a return on their investment, other than paying themselves as employees.  If you intend to run a small, lifestyle business, having an exit strategy may seem less important, but it plays an important role as it is directly tied to your succession planning. 

Next week, we will start discussing the first of several types of exit strategy, the Initial Public Offering.

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