The first question you’ll probably want answered when looking at a company to invest in is ‘how much profit do I stand to make?’. The second should be ‘when?’.
Early-stage investing is a high risk, high reward strategy. You stand a better chance of a big pay-out when the company exits, but until then, your shares are ‘illiquid’ and can’t be sold. Without an awareness of a company’s exit strategy, you won’t be able to plan your long term investment strategy, and your funds will be tied up for an indefinite period of time.
How do I find out a company’s exit strategy?
The exit strategy will be outlined in the company’s business plan and investor pitch, and should be read with maximal care. Your investment will amount to nothing without solid, inbuilt plans for payday. Is the startup aiming for a merger or acquisition, or to make an IPO? How will they transition? And crucially, what are the timescales?
You can deduce a general idea of exit strategy plans from the type of startup it is.
Disruptors vs. challengers
If the company is an innovative startup, bringing something totally new, reinvented, or reimagined to the market, it is likely to be a market disruptor. They will probably be seeking a merger, acquisition, or IPO (more on these below). This is because large, established companies can give them access to vastly scaled-up systems, funds, premises, and technical know-how.
A startup founder will be more likely to retain shares and control in the case of a merger or acquisition, as they are often “the brains of the operation”. Classic disruptor startups include Netflix and Tesla - both succeeded in changing decades-old consumer habits in the way we watch TV and power our cars.
If the company is either already established, and/or is offering a product or service that already exists, it is a market challenger. It challenges established competitors by doing things better, faster, or more affordably. A startup founder is not necessarily looking to dominate the market or change the world, but to acquire a certain portion of an existing market in order to maintain steady sales.
The crucial difference between the two is that challengers may not plan to exit. They don’t have the same needs or ambitions as a disruptor. They might make good candidates for long term, steady returns. But if you're looking for a big payout, disruptor brands are where you need to be focused.
Types of exits
Mergers and acquisitions
One of the most common exit strategies for crowdfunded startups is either merging with or being acquired by a larger company. In this scenario, the bigger company will take over, sometimes keeping on staff to smooth the transition, streamline operations, and allow them to cash out. The larger firm may have a controlling stake, as in the case of PayPal’s recent acquisition of Honey, in which the Honey co-founders continue to work on product integrations and scaling technology, or total control.
Many new investors make the mistake of thinking a merger or acquisition deal means guaranteed success, and a big payday for all involved. But the harsh truth is, an estimated 70-90% of them fail after the deal is made.
Integrating human teams is not the same as integrating systems. There has to be a shared vision that extends beyond the shared desire to generate profit. Founders will have to relinquish a degree of control. Newly forged departments must learn to play well together.
So how do you spot a company or startup to invest in that’s likely to make a successful exit via a merger or acquisition? The qualities we discussed in our Investing 101 article on company leadership demonstrate the characteristics that signal a leader will be able to handle major developments at this scale.
It’s also a good sign if a company’s plan includes a focused idea of who they want to be acquired by from the very beginning, a strategy for how they plan to achieve this, and a timeline for how long it will take.
IPO (Initial Public Offering)
IPOs give investors a chance to sell their investment in the startup, on a stock exchange. Often, the earlier you buy in, the higher your chances of a big ROI.
A startup will pursue this strategy for two main reasons: to raise capital, and to provide an exit for early investors.
Examples of big IPO winners include Twitter, whose shares gained 72.69% on its first day of public trading in 2013, and LinkedIn, whose market debut saw its share value skyrocket from USD $45 to $94.2. That’s an increase of 109.44%.
In some cases, a company or startup will choose to remain private, but enable investors to sell their shares internally. This is a way of enabling investors to exit without the time and expense involved in an IPO.
If a company chooses to remain private, there are no big buy-outs and no dramatic stock market debut.
However, VESTIUUM is working on a new model that will allows you to ‘tokenise’ your shares if the company remains private. This means they can be monitored, liquidised, and traded. This is a new and innovative investing system that means no waiting and worrying about ‘liquidation events’ (like acquisition or IPO) that may never happen. We don't currently have an ETA for this, but make sure you sign up here for updates.
This strategy is particularly beneficial for early investors concerned about liquidity. It’s also a necessary step-change. Companies are now staying private for longer periods of time.