This article is the fourth in the Entrepreneurship Series.
When starting a company, probably the last thing any entrepreneur thinks about is his exit strategy. The exit strategy, sometimes referred to as a “liquidity event” or “harvest strategy” is basically the entrepreneur’s way of “cashing out” of their company. This is the part where years of hard work come to fruition and turn into profit. Cashing out is often not as simple as it seems. There are numerous ways of converting the non-liquid asset of equity in a private company to the liquid asset of cash, and each is fraught with it’s own unique pitfalls.
The Lifestyle Company
While this isn’t an exit strategy per se, it is certainly a way to extract cash from your business, without giving up any ownership. If you’re running a sole proprietorship, you’re pretty much free to do whatever you want – and that includes setting your own salary or paying yourself bonuses. The Lifestyle Company is one that operates to make profits for itself, but also to support you, the owner’s, lifestyle. This type of company doesn’t strive for explosive growth or high valuations, as it exists to provide you with a stable and sizeable income year in and year out. Of course, the size of that income probably depends on your profits, so growth cannot be totally ignored. You must keep in mind though, that any money you take out of the business as salary and bonuses is money that the company cannot spend to support itself. If your business requires capital to grow, taking too much out now can really hurt your company in the future.
An acquisition is one of the most popular exit strategies, especially among today’s startups. Today, large companies such as Google and Yahoo are recognizing that growth through acquisitions is often easier and cheaper than organic growth. This means that it’s easier for a large company to purchase a small company to gain entrance to a new market, rather than trying to break into that market themselves. This is good news for entrepreneurial companies that can distinguish themselves and attract customers early in their lifetimes. Acquisitions are usually quite profitable for the investors in the acquired company, and depending on the terms, can still leave them with a lot of control over their product. Often, a larger company will choose to keep an acquired company mostly autonomous, especially if it has a very strong brand or management team. An acquisition can often prove the most desirable exit for the startup founder, allowing the conversion of equity to liquid cash, while often retaining a large amount of control over their venture.
Initial Public Offering
An Initial Public Offering, also known as “going public”, is the most profitable and most high profile exit strategy. However, it is also the hardest to successfully execute, and the rarest. Fewer than 100 companies go public every year, and there are only about 7000 public companies out of the millions in operation in the United States. Having a successful IPO is equivalent to going pro in sports – your chances of getting there are almost infinitesimal, but the payoff is huge if you do.
If going public is a feasible option for your company, the first thing you’ll have to do is hire a team of experts who will assist your business in its IPO. You’ll need a law firm, an investment bank, and an accountant. Choose candidates for all three of these positions that are well qualified and experienced with IPOs – they will manage most of what goes on with your IPO.
Another important and time-consuming task facing the IPO team is the development of the prospectus, a business document that basically serves as a brochure for your company. Since the SEC imposes a “quiet period” on companies once they file for an IPO, (which generally lasts about 25 days after a stock starts trading) the prospectus will have to do most of the talking and selling for your company during the most important part of your IPO. The prospectus should include the past five years of financial data for your company, information on the management team, and a description of your target market, competitors, and growth strategy. There are other key components as well, which your IPO team will make sure are included.
Being a public company comes with certain benefits and drawbacks. The more immediate positive is the large amount of cash raised through an IPO, which can enable solid growth. Also, after going public and converting your company’s equity into the currency of stock shares, acquisitions and changes in ownership are made much easier. All you need to do is buy and sell stock. Furthermore, as a public company, you’ll enjoy increased exposure and prestige, which will help you hire and retain the best executives and employees.
However with increased exposure comes increased regulation and scrutiny. A public company is required to regularly file detailed financial statements with the Securities Exchange Commission, and is subject to accounting audits. Your newly public company will also be subject to the scrutiny of market analysts and the public in general. All of your strategic moves will be analyzed, and the market’s opinion of them will affect your stock price. Analysts will regularly make forward-looking statements about your business, and it will be crucial that you meet these expectations, or risk a decrease in stock price.
In summary, there are a few different options for exiting your business, each with a different set of benefits and drawbacks. It’s impossible to say which is the “best”, as each business owner has a unique set of goals, and a unique expectation of what they expect out of their business.