Startup Exit Strategy- Exit Options for Venture Capitalists and Founders-Part Two

May 28, 2021 by Soject

Exiting the startup is the most important and difficult step in the management process of a venture capital fund. It determines the fund’s return on investment. In the previous article, we discussed the concept of startup exit, the importance of leaving for venture capitalists and startup founders, as well as some of its options. In the current article, first, we will look at the other options available for exit. Then we will discuss the final decision-makers of this process and successful exits.

Secondary Sale

In this exit method, the shareholder or venture capital fund sells its shares in the secondary market. It means Matching or CrowdFunding websites that allow the purchase and sale of shares of private companies such as MicroVentures and SharesPost) to legal and real investors. Of course, selling shares to individuals in this way requires the formation of an LLC (Limited Liability Company) or an SPV. SPV or Special Purpose Vehicle is a company that will not go bankrupt if the parent company goes bankrupt.

Venture capital funds sometimes use financing to sell their shares. Their motivation is the size of these transactions. The higher the trading volume is, the higher the income and wages of the fund will be. However, the value of establishing a relationship with the fund/venture capital firm as a stock seller can be the motivator.

Therefore, in cases where the company does not need financing, and new or existing investors are seeking to buy shares, the willing shareholders can cash their shares and leave the startup.

Sometimes the employees and founders of the company, as well as the initial investors, sell all or part of their shares through this method. That’s due to the long time required to leave through the merger and acquisition or initial public offering of shares.

This market allows investors to buy shares of successful and grown companies and carries less risk. For this reason, in most parts of the world, some venture capital funds have been formed. They invest in buying stocks in this way, such as MicroVentures.

In this type of withdrawal, the company may prevent the shareholder from selling the shares. Of course it is feasible in cases with company has the right of first refusal. They want to buy the shares itself. However, sometimes the possibility of exercising this right is low due to the desire of companies to increase the number of shareholders.

Exiting through Co-Sale

This type of exit has not been mentioned in the venture capitalist literature. I have proposed it simply because of the desire to cover all the processes considered some kind of exit.

Sometimes investors desire to have the right to sell a percentage of their stock at the same price as the founder intends to sell. Activating this right in a situation where the founders plan to sell their shares at a favorable price can be considered a kind of partial exit.

Sale to another Investor

For venture capitalists, selling stocks to other investors is based on a life cycle fund. Therefore, a venture capitalist who invested in a startup in the early stages may sell his shares to a Private Equity fund later. The acquiring company is likely to finance and invest in the expansion phase of the company.

The thing to consider in this type of exit is the different goals of the two sides of the transaction. The seller or investor who is a shareholder of the company and intends to leave the startup seeks to maximize the return on investment. On the other hand, the buyer wants to buy stocks at the lowest possible price to maximize the return on their investment in the future. This conflict of interest makes the negotiation process difficult for both parties.

Write Off

This  exciting way is considered the most undesirable one and accrues due to the failure and bankruptcy of the startup. Consequently, this method is more common for venture capitalists who invest in startups’ seed-phase or early stages.

Investing in startups in the early stages is accompanied by higher risk. That’s because of reasons such as the product not fully matching the target market, an overly ambitious business plan. So, here is the risk of bankruptcy or not receiving the actual value of the share at the time of departure. The only income of venture capitalists from this exit is selling assets such as brand, physical equipment, etc.

Private Equity Buyout

This method, which is not very common, has been used on a global scale in recent years as a way to get shareholders out of technology-driven companies. For example, in the first half of 2017, venture capital funds withdrew from 43 technology-driven companies by selling shares to private equity funds. However, according to data released by the Pitchbook platform, the number of exits through this way is more than the numbers through the initial public offering of shares in the first half of 2016.

Sometimes the attraction of entering these funds for shareholders is to compete with the public market and strategic investors. That is yield by offering higher prices that are sometimes even several times the fair value.

Another attraction is the possibility of remaining a shareholder in the new company (the company acquired by a private equity fund and then merging with one of the companies in the fund’s portfolio). In addition, unlike the initial public offering of shares on the stock exchange, there is no prohibition for shareholders regarding the sale of shares in the six months prior to the exit.

I should note that all exit methods mentioned in the blog can occur in one of two modes: Partial Exit or Full Exit. In the case of a Full Exit all shares are sold and converted into cash through the initial public offering or acquisition of shares. While in the case of a Partial Exit, the stakeholder only sells a part of the shares.

Are founders forced to sell startups under pressure from venture capitalists?

Which of the parties in startups decides to leave completely? Venture capitalists or founders?

Fred Wilson, the co-founder of USV Venture Investment Company, has experience investing in successful startups. Some of these startups are as follows: Twitter, Code Academy, Stack overflow, Tumblr, Foursquare, Zynga, Kickstarter, Lending Club, etc. He wrote an article that  I recommend you read.

How to leave the startup successfully?

You can find the answer to this critical question in this CB Insights sentence. Although this is a simple sentence, it’s based on reviewing and analyzing the available data and information from the exits made during the history of investment:

After working through the data on the biggest VC exits of all time, we found that some of the best VC deals of all time didn’t come from tactics out of a playbook. They were the result of research, strong convictions, and committed follow-through.