IBS Consultants Corporate Legal: Learning the Importance of Investors and Promoters in Business
We come to the final leg of the start up series this month. We started with Structuring Start ups and proceeded to discuss different aspects of the start up ecosystem – Compliances, Due Diligence, Intellectual Property, International Expansion, Start up deck on pitching business and ESOPs.
In this edition, we will look at the exit strategies available to the promoters/investors and how they can leverage it to their advantage as well as for future growth of the company.
Why Exit?
This is a pertinent question, especially when a start-up has been a dream project and is going to be very successful. This happens when a start up promoter wants to turn his ownership in business into money. Many young entrepreneurs nowadays aim to establish a business, nurture it to make it attractive to a purchaser and sell it. Also, there are start up entrepreneurs who get older and want to move out of their role. Yet again, there are others who just like the challenge of starting a business but don’t intend to run it on a long-term basis.
Sometimes, promoters need to exit due to mandate by investor, or to fulfill the commitment to investors who have required to move out after a stipulated time, in return for funds. In these cases, it is the liquidity or other promoter constraints that force an entrepreneur to quit even if he intends to continue.
An investor, say an angel investor or venture capitalist, needs an exit strategy because exit is what gives him return. The exit strategy in a start up funding pertains to investors who previously put their money in a start up and exit years later with a lot more money than they had invested.
Exit Strategies
Merger & Acquisition (M&A)
Here the startup merges with a similar and larger company. The bigger company is looking for complimentary skills and would prefer to buy a similar start up than creating it in-house. Some mergers like in case of Facebook-What’s app help to expand the footprint and capture the market.
Sale/Strategic Acquisition
This is not M&A as the two entities don’t get combined into one. But it is a good way to cash out and pay out the investors and self. One compelling reason is that equity investors need a return which is unlikely to be realized unless it is cashed out. The buyer is usually someone who has the skills and expertise to scale it operationally.
Sometimes, start ups are sold to a bigger company for profit. The buyer takes over the start up using cash or stock as compensation. The promoters and key employees from start up often stay at the company for a stated period to vest the stock and to be able to cash out. This provides a return to the founders, employees and investors.
IPO
This is usually in case of mature technology companies, where raising funds from VCs or private equity firms is not a feasible option. Also, IPO is preferred to give an exit to the VCs and private equities.
People who own the business are the ones who determine the exit strategies based on their objectives. Though the promoters initially own 100% of the business, their share gets liquidated over time as they avail financing options from venture capitalists, angel investors, equity investors or individuals and these shareholders thereby have a say in any potential exit strategy. On a fundamental level though, an appropriate strategy should ask and answer these basic questions:
1. What are the liquidity options?
2. Do you want to continue in business?
3. What are current market conditions?
This blog is authored by A. Loganathan, representing India Business Solutions (IBS) which is a boutique advisory firm helping a lot of Start ups in India and Singapore in fulfilling their aspirations. Loganathan is heading the Singapore operations of IBS and can be reached on loganathan.a@consultibs.sg.
