What is an Exit Strategy?
An exit strategy is a plan for a partner or owner to transition out of ownership of a company. It is accomplished through a merger and acquisition (M&A) with another company, through an initial public offering (IPO) to investors, through a transfer to a successor (e.g., family member), through liquidation, or through a management buyout by employees.
Exit strategies are plans executed by business owners, investors, traders, or venture capitalists to liquidate their position in a financial asset upon meeting certain criteria. An exit plan is how an investor plans to get out of an investment.
An exit plan may be used to:
Close down a non-profitable business
Execute an investment or business venture when profit objectives are met
Close down a business in the event of a significant change in market conditions
Sell an investment or a company
Sell an unsuccessful company to limit losses
Reduce ownership in a company or give up control
Exit strategies are often used when the owner wants to cash out their ownership in a company.
Bankruptcy is another example of an exit strategy that is often considered in a liquidity crisis or other financial struggles for a company; however, it is usually less preferable and offers a less profitable outcome for business owners.
Exit strategies can also be used to prepare for the end of a contract. It can be due to poor performance, changes in company strategy or hierarchy, or the end of an existing contract. Such strategies can be after achieving a pre-established goal or to mitigate loss, either way, taking their remaining value out of the company.
Liquidation as an Exit Strategy
Liquidation entails the closing of a business through the sale of all its assets. The strategy is often used when a business cannot be sold through any of the other methods, usually due to dependence on a specific employee/owner of the company or overall poor strategy/performance.
Liquidation as an exit strategy will often generate low returns, and any value of current clients will not be recognized in the sale of the company. Business owners should consider restructuring for the purchase of the whole company, rather than a liquidation to optimize returns.
Gradual Liquidation as an Exit Strategy
Gradual liquidation as an exit strategy is similar to regular liquidation, but it occurs over an extended period. It is most common for owners who want to wind down their business.
The systematic exit is accomplished by taking profits out of the company through large salaries, bonuses, or dividend payments, rather than reinvesting into the company.
Simultaneously, the operations of the business will slow down until it is too small to operate. Often, small business owners who want to reduce their workload slowly towards retirement will choose the gradual liquidation strategy.
Transfer to a Successor as an Exit Strategy
Transferring a company to a successor will usually keep the businesses within the owner’s family. It allows for the same or similar vision of the company to be continued and can keep the previous owner involved if that is their wish.
Some transitions go less smoothly based on the drive and knowledge of the individual inheriting the corporation.
Sale to a Business, the Open Market, or Through an IPO
A business sale to another organization requires unique positioning to make it an appealing acquisition to the other company. Corporations that are looking to acquire a new business segment will be looking for synergies between the brands or operations, a chance to reduce competition, or as a move to increase their market share.
Selling to the open market is another exit strategy and is often used when a company is highly sought after, and the demand for it can drive prices up – higher than that of a sale to a business.
Finally, an IPO (initial public offering) can provide an exit for private company owners who are looking for large profits and want to see their business continue to grow in the future through equity financing.
Trading Exit Strategy
Trading exit strategies are used when dealing with securities and portfolio management. Although similar in theory, exit strategies and trading exit strategies are very different.
Trading exit strategies are used to prevent risk and maximize profits. Traders who fail to establish a strong exit strategy often lose out on potential growth or end up with a loss.
Some methods often include “take-profit” and “stop-loss” tactics, both of which turn to market orders to sell when a specific price is reached. They are only two of the many complex trading strategies used in securities markets.
Exit Strategies for Start-ups
Exit plans are commonly used by entrepreneurs to sell the company that they founded. Entrepreneurs will typically develop an exit strategy before going into business because the choice of exit plan has a significant influence on business development choices.
For example, if your plan is to get listed on the stock market (an IPO), it is important that your company follow certain accounting regulations. In addition, most entrepreneurs are not interested in a big-company role and are only interested in starting up companies. A well-defined exit plan helps entrepreneurs swiftly move on to their next big project.
The exit plan chosen by the entrepreneur depends on the role they want in the future of the company. For example, a strategic acquisition will relieve the entrepreneur of all roles and responsibilities in his or her founding company as they give up control of it.
Importance of an Exit Plan
It may seem counter-intuitive for a business owner to develop exit strategies. For example, if you are an e-commerce business owner with increasing revenue, why would you want to exit your company?
In fact, it is important to consider an exit plan even if you do not intend to sell your company immediately. For example:
Personal health issues or a family crisis: You may be affected by personal health issues or experience a family crisis. These issues can take away your focus on effectively running the company. An exit plan would help ensure the company will be run smoothly.
An economic recession: Economic recessions can have a significant effect on your company and you may want your company to avoid assuming the impact of a recession.
Unexpected offers: Large players may look to acquire your company. Even if you do not have any intentions of immediately selling the company, you would be able to have an insightful conversation if you have thought of an exit plan.
A clearly defined goal: By having a well-defined exit plan, you will also have a clear goal. An exit plan has a significant influence on your strategic decisions.