PS#052: Exit Analysis – Types of VC Exits (Part 1)
In a previous issue of Preferred Shares, I discussed using newsletters to create your own venture capital database.
More specifically, I highlighted tracking exit events (e.g., M&A, secondaries, etc.).
Today, we’re going to dive a bit deeper on that idea and discuss how to think through the different exit scenarios for your investments.
Over the next few issues, we’ll walk through…
Why track this information?
What types of exit strategies exist?
How do you think through exit strategies?
Let’s get started.
Why should we track information about exits?
At the end of the day, venture capital is a results based industry.
VCs are graded on the capital that they are able to distribute to their investors. To put it simply, for the capital they were given, how much cash were they able to return?
Historically, venture capital funds are expected to meet (or exceed) 25-30% IRRs and 3-5x multiples. If you’re unable to meet these types of returns, it’s going to be tough to last over the long-term in this industry. Limited Partners have other ways to invest their capital, whether it’s with other venture investors or turning to other asset classes. If you’re not performing, they will give their capital to someone else to invest.
With that being said, we need to think through the potential exit strategies as part of our investment process. We can make all the investments that we like, but if there’s no exit path in sight, none of it really matters.
We need to plan our investments with the end in mind (if at all possible).
Types of exit strategies.
In order to plan with the end in mind, we need to understand the different exit opportunities available to venture capital investments.
For simplicity, I like to bucket the exit opportunities into three categories…
Option to Sell (via Direct Listing, Secondary, or post-IPO)
Change of Control (M&A, Management Buyout, or Asset Sale)
Liquidation
Let’s dive into each of these in more detail…
Option to Sell
For this category, I’m thinking about opportunities that provide investors with the option to sell or hold their shares. While shares are sold in almost all forms of a successful exit, there are certain situations where investors have the choice. These situations include…
Post-IPO sale: An IPO (“Initial Public Offering”) is when a privately-held company goes public by offering shares of its stock to the public for the first time. This is often seen as the most prestigious and potentially lucrative exit option. HOWEVER, an IPO in of itself is not an exit. Let me say that again, an IPO is not an exit. It’s actually another financing round since the company is raising more capital (just in the public domain). Selling shares in the public market AFTER an IPO is the actual exit.
Direct listings: Similar to an IPO (but different), a direct listing allows a private company to go public and have its shares traded on a stock exchange. However, in a direct listing, the company doesn't raise new capital through the sale of shares; instead, existing shareholders can sell their shares directly to the public. Since existing investor shares are actually being sold, this does count as an exit.
Secondary: In a secondary sale, existing investors sell their shares to other investors or institutions. This can provide liquidity to early investors without requiring the company to go public or be acquired. Secondary sales are more common in later-stage investments.
Change of Control
In this category, the company is actually being sold. There is a “change of control” or a change of ownership. These situations typically include…
Acquisition: This exit occurs when a larger company buys the startup or private company. Acquisitions can provide a quicker and more certain exit for investors and founders compared to an IPO. The acquiring company may pay cash, stock, or a combination of both for the target company. This is the most common form of exit for startups and something we’ll discuss more in the next issue.
Management Buyout (MBO): In a management buyout, the company's management team, often with the help of outside investors or private equity firms, buys out the existing shareholders, including the venture capitalists. This can be a way for founders and management to regain control of the company.
Merger: A merger involves the combination of two companies into a single entity. In some cases, this can be a strategic move to create a larger, more competitive company. Mergers can result in the issuance of new shares or a combination of cash and stock for the shareholders of both companies.
Liquidation
Finally, we have liquidations.
In some cases, a startup may not be successful, and the only option is to shut down the company and sell its assets. This often results in a loss for investors, but it is a way to recover some value from the remaining assets.
Building your exit analysis.
When it comes to VC exits, those are your options.
In the next few issues, I’m going to dive into each category in more detail. We’ll walk through some frameworks for how to think about potential exit options in our investment process.
