Navigating the path to exit: Exploring the 3 most popular startup exit strategies

In this article, we'll delve into the three most popular startup exit strategies, factors determining the deal and stakeholder expectations.

Building a successful startup is a challenge that requires unwavering determination, operational excellence and a well-thought-out growth strategy. Once a startup enters the maturity stage, has built a large market share and reached a high valuation, the long-awaited exit moment for investors comes. Choosing the right path, known as Exit, is one of the most critical aspects of a startup's life cycle, having a profound impact on its founders, investors and stakeholders.

When we think about the startup’s exit strategy three most popular ways often come to mind – acquisition by an industry player, IPO, and takeover by a financial investor.

Acquisition by a market player: fast liquidity with trade-offs

The acquisition is a common exit strategy for startups, where a larger, established company purchases the startup to incorporate its products, technology, or market presence into its operations. This strategy offers founders and investors a relatively swift liquidity event, allowing them to realize returns on their investments. The acquiring company often brings additional resources, such as technology, talent, and market reach, which can further fuel the startup's growth. However, it comes with the trade-off of potentially losing some degree of independence as the startup integrates into the larger organization.

What are the common deal drives for such transaction? On the buyer's side, acquisitions are driven by a strategic fit, where the startup complements existing operations or strategic objectives. Acquiring valuable intellectual property or proprietary technology is another motivator, as well as the desire to expand into new markets or customer segments.

On the seller's side, financial gain is a primary driver, along with the prospect of faster growth through synergies with the buyer. Mitigating risk by aligning with a more established entity can also be a consideration.

IPO: accessing capital markets

An Initial Public Offering (IPO) is the process by which a startup becomes a publicly traded company by issuing shares of its stock to the general public. This strategy offers access to a significant infusion of capital, which can be used for expansion, research and development, or even debt reduction. Founders and early investors can achieve liquidity without necessarily selling their entire stake. However, the IPO process involves stringent regulatory requirements and ongoing reporting obligations, and the timing is crucial, as IPOs are subject and dependent to market conditions.

IPO of a portfolio company is both the most desirable and the rarest exit method. According to the Q2 2022 PitchBook-NVCA Venture Monitor report which follows the US VC market, IPOs are responsible for the majority of exits value-wise, but their number is relatively small. The most common type of exit is an industry investor takeover, which is the case for approx. 2/3 of all deals.

The most common deal drivers for buyers outline that going public enhances brand reputation and credibility, provides access to capital markets for future financing, and can be used to facilitate stock-based acquisitions. For sellers, on the other hand, an IPO aims to raise substantial capital, increase the company's profile in the market, and provide an exit opportunity for existing investors.

Acquisition by a financial investor

An exit strategy involving acquisition by a financial investor is a move that often aims to maximize returns for both the startup founders and the investor. In this scenario, a financial investor, such as a private equity firm, purchases the startup with the intention of enhancing its value and ultimately selling it for a profit. This approach can provide founders with an opportunity to secure liquidity for their hard work and initial investments while also benefiting from the expertise and resources that the financial investor brings to the table.

This exit strategy can be a win-win situation when executed effectively, aligning the interests of both parties.

Deal drivers play a pivotal role in shaping the acquisition by a financial investor, who often seeks startups that fit well within their investment portfolio and can benefit from their expertise and operational resources. On the one hand financial investors may target startups with innovative technologies, strong intellectual property, or a unique market position that can be further developed and monetized. On the other hand, for startup founders and stakeholders, deal drivers often include the desire for a strong financial offer, the potential for accelerated growth through synergies with the financial investor's network, and access to their industry-specific knowledge.

Meeting stakeholders goals and expectations

When it comes to startup exit strategies understanding the goals and expectations of various stakeholders is crucial for a successful transition. Firstly, for startup founders and their teams, the primary goal is often to maximize the return on their hard work and investment. In the case of an acquisition, founders may seek not only financial rewards but also the opportunity to align their vision with a larger company and continue to drive the innovation they're passionate about. In an IPO, founders aim to access public capital markets to fund further growth and expansion. However, it's essential to balance these financial objectives with concerns about maintaining the company's culture and autonomy, as these elements can be vital for retaining top talent and ensuring long-term success.

From the perspective of venture capital funds, the goal of an exit strategy is to deliver significant returns to their investors. This typically involves securing the best possible valuation for the start- up. For acquisitions, it may also involve ensuring that the acquiring company is a suitable fit in terms of strategic alignment. In the case of IPOs, the goal is to take advantage of favorable market conditions to achieve a successful public offering. Moreover, VC funds may be interested in maintaining a stake in the company post-IPO to continue benefiting from its growth.

Lastly, for the startup's employees and customers, their expectations during an exit strategy revolve around continuity and value. They hope that the transition will not disrupt the products or services they rely on. In the case of acquisitions, they may also seek clarity on how their roles will evolve. For investors beyond the VC fund, such as angel investors or crowdfunding backers, their expectations will align with their investment objectives, which could range from immediate financial returns to long-term capital appreciation.

The crucial role to choose right

Choosing the right exit strategy is a critical decision for startup founders and investors. Each option has its own set of advantages and challenges, and the choice should align with the startup's goals and circumstances. Clear communication and strategic planning are vital to ensure that all stakeholders benefit from the chosen exit path and that the startup's culture and value are preserved in the process. Whether it's acquisition or IPO, understanding the deal drivers and managing stakeholder expectations is key to a successful exit that benefits all parties involved.

Author: Magdalena Pawłowska, Partner, Level2 Ventures

This article comes from magazine:
FOCUS ON Business #13 November-December (6/2023)