Investment exit strategy

The sale of private company shares in an exit is one of the largest wealth-creating events for shareholders. In some deals, shareholders can receive the equivalent of more than 10 years of annual profit distribution. Simply put, an investment exit is the event where shareholders sell shares in their private company after it has reached attractive strategic and/or financial value to other investors. A successful investment exit strategy orchestrates several key elements that are worth focusing on, especially in what could be a once-in-a-lifetime event. Unfortunately, not all investment exits succeed, and some exit attempts may actually backfire. It is quite painful to see founders who have grown companies for many long years incapable of enjoying the immense potential wealth or securing the future of their legacies. Along the following lines, several takeaways are highlighted to capture the largest value possible and avoid the worst from the next exit event.

Announcement of the exit

An exit is not the best word to start a conversation with investors, nor with a company's internal (employees) and external (suppliers, clients, etc.) stakeholders. Before announcing an exit, which could trigger surmountable worries, a clear investment exit strategy should be formulated, highlighting the company's readiness, future potential, the fate of stakeholders, and the appropriate type of new investors.

What company qualifies for an exit?

The readiness of a company and its future potential are the primary concerns of new investors as they deploy funds to grow the company while sellers receive large payments and pass on their responsibilities. What makes a company attractive for an exit is that its owners have built it to reach advanced strategic and financial milestones, making it easier for new investors to pick up and accelerate growth to the next level, possibly making their exit strategy at a higher valuation. It is this advanced stage that prices a premium on shares. Companies in early stages with no significant milestones are not attractive candidates, and their owners would not be in a strong position to demand a premium on exit shares.

These are general forms of the exit path: a simple yes or no. However, when we advise companies with great potential, it is important to take it a step further and fine-tune the exit scenario for both companies and potential investors. It is essential to conduct a close assessment with company shareholders to check readiness, valuation path, and optimal path to exit through the analysis of several factors affecting company performance, including:

• Economic cycles (recessions vs. booms, interest rates)
• Industry cycles (shifts in consumer behavior, technological advances, competition landscape, supply chain, etc.)
• Company-specific stages (early stage pre-revenue, strong revenue growth, maturity, decline, size, financial health, shareholder structure, management team, etc.)
• Timing of the exit

Who acquires shares in exit events?

At Ace, our preference for buyers is sophisticated funds—private equity or strategic funds—that have successful track records in investments and exits (or divestments-not only in investments). Such funds have long-term interest and experience in the full cycle of a company's growth and preserving legacies. It may be easy to invest, but the true test of an investment cycle is the eventual exit to other investors who pick up, taking the company from one stage to the next. We don't recommend companies be sold to parties only to be destroyed after their owners exit; it sends a negative image to the entire investment industry and discourages continuous investment cycles. Namely, here are the broad types of potential acquirers of private company shares:

• Private equity funds
• Strategic investors (players in the same industry)
• Pre-IPO investors (an IPO is an Initial Public Offering; these investors are focused on acquiring privately held shares that are almost ready for an IPO, holding them for a period of 2–3 years, then earning a premium when the shares are listed in an IPO)
• IPO markets (usually the latest stage after several investment rounds, earning a large premium on shares; the selection of a stock market to list shares is a strategic decision to consider)

How are exit deals designed?

Exits can take several forms, as highlighted below:

• Full buyout: sale of 100% of shares; common with strategic investors
• Majority buyout: sale of a majority of shares while retaining a minority; this is common when the presence of existing shareholders is required to give comfort to stakeholders or assist in the handover. It can be part of a staged buyout that starts with a majority buyout and then the sale of the remaining shares a few years later.
• Mix of capital raise and buyout: popular with private equity funds that prefer their funds deployed into the company's growth plans rather than into the accounts of previous owners. A mix is designed to align the interests of such investors with the ambitions of existing owners.
• Partial buyout: popular with owners that do not want to sell the majority of their shares at a current stage but wish to invite other investors.

In addition, a wide range of combinations for buyout options can be designed through a close analysis of the company's business plan and negotiations on the deal table.

People behind the exit decision: #peopletopeople

It is essential for dealmakers to build a deep understanding of shareholder profiles and their motives for exits to advise on the best exit scenarios that align interests with future investors. Popular topics to address may involve personal plans, the future of the company and its legacy, plans for the employees, etc. Common profiles and motives are:

• People who founded the company and built it all the way to advanced stages, or a legacy in some cases
• People who acquired the company from others at early stages and either succeeded or failed in management. If they succeeded and were able to enhance value, they are in a position to sell it at a higher valuation than the initial acquisition and enjoy a premium. However, if they failed and the company's performance deteriorated, they would be in a position to accept the same value of acquisition or a smaller value, depending on the circumstances and deal dynamics
• People who inherited a company at an advanced stage and are not interested in growing the company (2nd generation or family members)
• People with personal perspectives on wealth, such as enjoying life, engaging in philanthropy, and buying legacy trophies
• People who only like challenges and taking risks early in building companies then sell their shares when everything is stable and growing. They never rest and always seek the next adventure
• People who like to engineer and experiment—like scientists and engineers—don't like to manage large-scale operations with a large number of people, so after scaling their ventures, they prefer to sell and let others grow or manage
• People who want to liquidate their current position and invest in other opportunities with higher upside (recycling strategy)

How to avoid a failure in investment exits

If an investment exit is not well orchestrated, not only will an exit be a failure, but it can backfire and leave a long-term negative impact on a company and its owners, which may not be reversed. If signs of a potential failure appear, it is advisable to avoid an exit altogether and seek professional advice from seasoned investment bankers. Common signs of failure include the following:

• Owners rushing to exit; the move to suddenly leave company and jump ship, indicating possible threats to the company; lack of a succession plan. If a company has great value, its owners wouldn't rush to sell it or accept any terms
• Valuation expectations from owners; extremely high (or low) valuation. It shows a poor analysis of the company's strategic and financial value. It could deter sophisticated investors (high valuations) or destroy potential wealth deserved by owners (low valuations).
• Absence of long-term strategic (business) plans. This could indicate the company has not been prepared for long-term growth; its stakeholders, including management and employees, and its long-term commercial relations with clients and suppliers do not reflect a long-term growth path. Unless new investors are able to execute restructuring plans and formulate the right strategy, the company could potentially destroy future investment value
• Poor records and documentation. Despite being a great company, this element can deter sophisticated investors who hire professional auditors, lawyers, and advisors to review their company's documents and raise reports to their investment committees
• Waiting too long for an exit decision after inheritance. Over time, and with a lack of proper management, a company's performance deteriorates and may reach the point of no longer being an attractive investment opportunity
• Shareholder structure. Conflicts between shareholders, driven by different motives, create potential problems at exits. It is advisable to organize and clear shareholder structures (capital tables) at the early stages of a company's life cycle; problems usually escalate when a company achieves strong financial performance in the advanced stages. Problems magnify the larger the number of shareholders making decisions

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