An important but often overlooked element of 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, which cover more than 80% of entrepreneurs, are:
Strategy #1: Selling to Outside Investors
Some entrepreneurs plan to establish a niche business that can ultimately be sold to a larger company. Serial entrepreneurs tend to just enjoy the startup phase and intend to sell their businesses off to new owners once the venture is afloat. Either way, it is critical to set up and operate the business with the goal of selling in mind. You must understand how valuation (how much a business is worth) works and plan your asset and financial management accordingly. You should be sure all business protections are in order (trademarks, etc.) and do the work to build brand goodwill within your market and industry. About two-thirds of all new startups consider selling to outside investors a likely exit strategy.
Strategy #2: Going Public
Many startups, especially those in high-tech industries, hope to sell out and grow rich through an IPO (initial public offering). If going public is in your plans, you must hire a competent, experienced attorney to develop your incorporation papers and protect your interests. While you need to understand everything that goes into your entity registration and agreement, you should not do this yourself. IPOs can be very complicated and are one of the very few things that entrepreneurs absolutely must retain a lawyer to handle. Again, your assets and books will have to be in very good order, and your timing for going public will have to be precise. About a quarter of all startups begin with the intention of going public, but the actual number that ever floats an IPO is much smaller. With the current state of the economy, it is likely to be more difficult 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 for all members to hammer out the what-if details and include them in writing in the Operating Agreement. For example, discuss what will happen if one partner wants to sell his ownership — will the other partner(s) have the first right to purchase? How much notice must a partner give? If they sell to an outsider, do the remaining partners have the right to approve the sale? How will the share of ownership be valued? If your exit strategy is to sell your share to your partners, it is critical that you make a plan for doing so before the business is launched.
Strategy #4: Pass On To Kids
Though a less common exit strategy than in past generations, about 20% of entrepreneurs intend to build a family business that can be left for the kids to run. In these cases, it is important to set up your business from the start with the intention of long-term growth. Building a solid foundation is critical, both in terms of marketing and financial management. In addition, you should discuss the best way to set up ownership of the business with a competent, 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 To Employees
Another exit strategy that has grown in popularity over the last decade is using an ESOP (Employee Stock Ownership Plan) to sell the company to the employees. Generally, these plans are established as trusts and the company makes tax-free contributions to the trust to buy shares of the company. Employees are usually eligible to participate after one year of service but do not take distributions until they leave the company, at which time the ESOP buys back their shares. Like any other strategy, there are advantages and disadvantages to ESOPs. Employees tend to be more productive and loyal, but having so many chiefs can make decision-making slower and more difficult. If you are interested in considering an ESOP as your exit strategy, you need to read up on the process and options and you will need a competent, 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 company yourself for the long term or build and sell like a serial entrepreneur, how you plan and run the business should be influenced by that goal. Consider your options and look into the details now so that you do not run into problems when you are ready to move on.