Hit The Road: A Guide to Startup Exit Strategies
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In merely seven years ending 2018, the volume of startup exits worldwide grew from 1,217 to 4,428. The ratio of acquisitions to IPOs has skyrocketed over the past decade. Yet, after a tepid 2022-23, all has not been sunny for angel investors with “exit anxiety”. Cold winds of turmoil may be sweeping through the landscape as we speak. Yet, dreams of sunnier times have not lost their vividness.
In this blog, we will examine the contours of a robust startup exit strategy –– one that growth-stage investors can eventually back. So let’s start from the beginning. We know angel investors provide crucial early-stage capital to startups. However, realizing returns from those high-risk investments can be tricky. This is where a well-drilled, prescient, and aware exit strategy comes in.
Our guide covers exit strategy for angels, the changing face of PE exits, and recognizing winning patterns that strategic acquirers seek.
Startup Exit Strategy Explained
An exit strategy is a plan on how an investor sells their stake in a startup and receives a return on their investment. The exit event generates liquidity for investors who have taken the risk of backing a young company. Exit sizes span a wide range, but mostly occur out of the spotlight:
? 1,200-4,400 annual startup?exits globally
? Typical acquisition size of?$10 million to $50 million?
? Most deals covered by?non-disclosure agreements??
For angel deals, the most likely exit scenarios are:
??Strategic sale: The startup is acquired by a larger, more established company
? Secondary sale: The angel sells their shares to another private investor
??Initial public offering (IPO): The startup goes public on a stock exchange
Conventional wisdom says that the best time to exit is after reaching sufficient scale to maximize valuation, but waiting too long risks missing the window for the highest ROI. Google's ideal acquisition size has been around 20 employees and an established business model, rather than very early or late-stage companies. However, economic cycles can also impact exit outcomes.
In a world where blockbuster IPOs get all the attention, smaller exits frequently deliver?strong returns?to angel investors with skin in the game. That being said, what is the outlook for exits looking like for angel investors in 2024? Let's dig a little deeper.
Poised for a Rebound in 2024?
Exit activity hit unprecedented lows in 2023. Public listings evaporated and corporate acquisitions dried up. Even sales to other PE firms stalled out with buyers on the sidelines.
PitchBook data reveals PE exit deal counts dropped 29% and value decreased 12.7% through the first three quarters of 2023 compared to the prior year.
The industry effectively pressed pause on winding down aging fund holdings. But that's not the full picture.
These trends mean PE firms now face a backlog of mature portfolio companies needing liquidity events. The traditional exit playbook of IPOs, strategic sales, and secondary buyouts shows little life.
However, there is some growing optimism for an exit rebound in 2024 as tailwinds emerge. The pressure on general partners to return capital to limited partners continues to mount.?
High demand colliding with even slightly more welcoming markets could spark an inflection point. Advisers expect both corporate and financial buyers to step up acquisitions. Markets have stabilized from recent volatility. PE firms also appear increasingly ready to consider lower valuations to lock in exits.?
VCs and investors await the recovery of the exit window this year. But it helps to understand what they're looking for. Let's go over the patterns of a robust exit plan.
What Ticks: Examples of a Winning Exit Strategy
Investors can recognize certain patterns that strategic acquirers may look for in the near and long term:
??Complementary product?to a larger, more successful brand
??Disruptive innovation?threatening the market leader's position
??Key patents?or intellectual property with competitive value
??Very high growth potential?if supplemented with greater resources
??Strong branding?and buzz in a hot category
? Skilled talent?and leadership to absorb
Startups that excel at these tend to elicit acquisition interest early before growing too expensive.
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Common Routes: What Does it Mean for an Investor to Exit??
Let's look at the most common ways in which angel investors achieve an exit:
A large proportion of startup exits happen through sales, mostly to strategic buyers. This liquidity event involves the outright sale of the entire startup to a larger acquirer in the same sector. Financial buyers like private equity firms may also purchase startups.
Trade sales typically generate significant returns for early investors and founders in one shot. However, key employees often need to remain for transitional periods. Trade sales also relieve startups from the ongoing reporting requirements of public companies.
A popular variation of the trade sale is an acqui-hire deal, where a large tech company purchases a promising startup solely to recruit its talented team without intending to advance the startup’s business.
Leaders at larger firms use selective acquisitions to continually inject innovative thinking from startups. While the startup itself shuts down, founders and angel investors still receive a payoff tied to the value of the talent itself.
Selling startup shares to another private investor constitutes a secondary sale transaction, which allows angels to cash out partially or entirely without an operational merger or IPO. Specialized secondary marketplaces and brokers provide some liquidity options.
Secondary buyers may include other angel investors, venture capitalists, family offices, or private equity firms willing to invest at somewhat later stages. The buyers subsequently aim to profit from their future exit. Secondary sales let angels pull investment returns sooner while allowing startups to stay private and independent longer. However, steep valuation discounts often apply to secondary sales.
IPOs stand out as high-profile liquidity events when startups “go public” by listing shares on stock exchanges so that anyone can trade the stock. IPO exits are complex and expensive but generate the highest potential valuations.
Venture-backed IPO volume fluctuates widely year-to-year, such as only about 50 in weak markets compared to over 250 IPOs when conditions peak. IPO windows tend to rapidly open and close along with broader economic sentiment.??
However, according to Pitchbook, the traditional routes may not be the answer after all.
"The industry is running out of time and options to wind down portfolio holdings. The traditional routes for exiting companies have been two-fold with four sub-components: (1) M&A sale to a corporate buyer; (2) M&A sale to a PE buyer; (3) public listing by way of an IPO, and (4) public listing by way of a reverse merger. Each was highly active for a solid decade, peaking in 2021 when a record 41.3% of AUM was turned over.
Since then, however, each has faltered as interest rates rose and liquidity conditions turned negative. It’s long been our thinking that the industry needs to develop a third major option for exiting companies and to do so quickly. True to form, the industry has been working ahead of these issues for many years now to devise new liquidity solutions for the funds, portfolio companies, and investors who need them."
In essence, a robust startup exit strategy is a strong proposition for an angel investor to sign that check. While recent months have shown a slump in VC-backed exits, there are signs that newer exit strategies will need to be developed for investors to get ROIs that match their risk appetite.
Here is a summary of the article:
? Exit strategies are plans for investors to liquidate ownership in startups to receive returns
? Strategic sales lead as the most common type of exit, followed by secondary sales and IPOs??
? Optimal timing balances growth maximization against missing the ideal window
? Startups with hot momentum or strategic value draw high early acquisition interest
? A backlog of M&As and IPOs could drive more exits in 2024
Sources:
Loved the deep dive into EXITS ??! Remember, as Warren Buffet wisely advised - The difference between successful people and really successful people is that really successful people say no to almost everything. Staying focused and selective is key! ?? #AngelInvestors #Wisdom