An important but often overlooked element in planning a startup is deciding how you want it to end. That is, knowing your exit strategy during the planning stage can strongly influence any number of decisions you need to make. The top five exit strategies, covering more than 80% of entrepreneurs, are:
Strategy #1 — Sell to outside investors
Some entrepreneurs plan to establish a niche business that can eventually be sold to a larger company. Serial entrepreneurs tend to enjoy only the startup phase and intend to sell their businesses to new owners once the business is afloat. Either way, it is essential to establish and operate the business with the goal of selling in mind. You need to understand how valuation works (how much a company is worth) and plan your financial and asset management accordingly. You need to make sure all trade protections are in place (trademarks, etc.) and do the work to build brand reputation within your market and industry. About two-thirds of all startups consider selling to outside investors a likely exit strategy.
Strategy #2: Go public
Many startups, especially those in high-tech industries, hope to sell and get rich through an IPO (initial public offering). If going public is in your plans, you should retain a competent and experienced attorney to develop your incorporation documents and protect your interests. While you should understand everything that is included in your entity’s registration and agreement, you should not do it yourself. IPOs can be very complicated and are one of the few things that entrepreneurs should hire a lawyer to handle. Again, your assets and books will need to be in very good shape, and your timing of going public will need to be accurate. About a quarter of all new companies start with the intention of going public, but the actual number that ever launch an initial public offering is far fewer. With the current state of the economy, it’s probably harder than ever to get rich through an IPO.
Strategy #3: Sell to Partners
Some startup partnerships are established with the intention of one partner buying out the others once the business is up and running. In any partnership situation, it is critical that all members work out what-if details and include them in writing in the Operating Agreement. For example, consider what will happen if a partner wants to sell his property: will the other partners have first right of purchase? How far in advance should a partner give? If they sell to a stranger, do the other partners have the right to approve the sale? How will ownership interest be valued? If your exit strategy is to sell your stake to your partners, it’s critical that you develop a plan for doing so before launching the business.
Strategy #4 — Pass on the kids
While it’s a less common exit strategy than in past generations, around 20% of entrepreneurs intend to build a family business that can be left to children. In these cases, it is important to set up your business from the beginning with the intention of growing it in the long term. Building a strong foundation is essential, both in terms of marketing and financial management. Additionally, you should discuss the best way to establish ownership of the business with a competent and experienced attorney. Leaving behind a thriving family business can be a great legacy, but only if the company is built to last.
Strategy #5 — Transfer employees
Another exit strategy that has gained popularity over the past decade is using an ESOP (Employee Stock Ownership Plan) to sell the company to employees. Typically, these plans are set up as trusts, and the company makes tax-free contributions to the trust to purchase shares of the company. Employees are generally eligible to participate after one year of service, but do not accept distributions until they leave the company, at which time ESOP repurchases their shares. Like any other strategy, ESOPs have advantages and disadvantages. Employees tend to be more productive and loyal, but having so many bosses can make decision making slower and more difficult. If you are interested in considering an ESOP as your exit strategy, you should read about the process and options, and you will need a competent and experienced attorney to help you set it up correctly.
The bottom line
Determining your exit strategy is an important part of startup planning. Whether you plan to run the business yourself for the long term or build and sell like a serial entrepreneur, the way you plan and run the business should be influenced by that goal. Consider your options and look at the details now so you don’t run into trouble when you’re ready to move on.