About exits

OK, I know, it is a bit strange talking about exits in the context of start-ups, but one of my students asked about it in class the other day and this reminded me how important is the planning for exit in the early stages. Not your (as founder) exit, of course, although why not?  So, let me share with you some of the solutions that I have worked with:

I suppose a vague dream for some people in a start-up is selling the business, or some shares, to a big company, or on the stock market (IPO, Initial Public Offering), for big bucks - images of Zuckerberg the Facebook IPO float across our minds here. That is an 'exit' of a sort, and rather rare, and I will talk more about stock exchanges in a moment, but first let's consider the more likely scenario.

More usually, the 'exit' discussions are with people and organizations that maybe involved in the early funding. As you will have seen in an earlier post (Looking for start-up capital?) most early stage funding comes from personal savings,  friends, or family. While they may care for you and trust you, they may imagine, or even say, that they want their money back eventually. This is also true of other early investors such as angel investors (business angels) or venture capital firms (VC's), These latter two, especially, are in the business of providing you with funds for their own profit. They want to see some return on their investment. So, let's focus on those people and organizations, whoever they may be, that want to get their money back eventually, with a profit. Recall that, in the absence of a stock exchange, any shares that you issue, are effectively worthless unless the holder can find some way of selling them on. So what are the solutions? 
1. Have an agreement (formal contract) at the beginning of the investment process. One way is to agree that after, say, three years, from start the founders have the right, but not an obligation, to buy back a certain number or percentage of the investors' shares according to some pricing formula, e.g. a fixed number of currency units (euros, say) plus a percentage of profits or a defined percentage whichever is higher. An addendum might be that after a certain time, or after a certain event (such as a certain level of after-tax profits, or a certain cash flow, etc.), then buy-back of any remaining shares (priced according to a pre-defined formula) is obligatory. This approach helps to re-assure the investors that they will get their money back eventually, with some profit, assuming the business does not go into liquidation.
2.  Alone, or in combination with the above conditions, one may issue a special class of shares for the external (non-founder) investors, such as preference shares. These are a class of shares that give certain preferences: fixed guaranteed percentage return (that may be cumulative if there are no profits in any year), or that give preference to payout in the event of a bankruptcy of the firm, or a rightof conversion to normal shares in the event of a listing on a stock exchange. Sometimes these preference share may be called 'redeemable preference shares', allowing for conversion to normal shares under some conditions.

As for the placing of shares on a stock exchange, many countries have a secondary stock market on which, subject to listing conditions, companies may be listed. These secondary markets are usually used by firms wishing to create a market for their shares (allowing shareholders to monetize their investment) without the list and reporting rigors of the major exchanges.

There you are folks, some ways to plan for, and manage, exit for some of the shareholders. Please leave comments and questions if you want to discuss more.