Raising Entrepreneurial Capital

COMPARISON OF RETURNS BY EXIT TYPE

The rate of return expecte d at exit is highly dependent on the type of exit

chosen. With the latest data, shorter-term returns are still very skew ed by the

late 1990s boom in new ventures and the severe market corrections of 2000

and 2001. Still, 10- and 20-year returns are highly indicative of the impac t of

exit type (Figure 7.1).

In the longer term, businesses showing sufficient growth potential to

attract venture capital still show the highest return, though private place-

ments, buyouts, and refinancing deals narrow the gap over time.

LIKELIEST OPTIONS FOR EXIT

Providing realistic exit strategies improves credibility with investors and

helps to reassure them about their opportunity to receive their desired

return. Realistic is the key word here, however. ‘‘We plan to IPO in 5

years’’ is not realistic for most companies and usually does not portray a

well-thought-out analysis of the company’s future prospects.

−40

−30

−20

−10

0

10

20

30

40

50

60

1 Yr 3 Yr 5 Yr 10 Yr 20 Yr

All Venture

All Private Equity

Refinance

Buyouts

Private Equity Return % by Type, End 2001

Figure 7.1 Private equity return percentage by type, end 2l. From the NVCA

website, http:

// www.nvca.com/nvca06_10_02.htm

232 Exit Strategies

While companies that can achieve the rapid growth and attractive returns

required for an IPO are rare, many business plans written to attract outside

investment still project an IPO within about 5 years as the liquidity event in

their exit strategy. Far more likely is exit through acquisition. Forecasting an

acquisition forces the en trepreneur to identify likely acquirers and explain

the value added to these acquirers.

In an article in Entrepreneur.com,

6

David Newton suggests that the four

basic categories of exit strategi es besides the IPO are, in order of occurrence:

. acquisition by a strategic buyer

. earn-out (buyout) by management team

. debt-equity swap (conversion of business debt to equity)

. merger with a similar firm

Let us discuss these before moving on to other options.

ACQUISITION

The term ‘‘acquisition’’ generally implies a sale to a ‘‘strategic buyer,’’

typically one involved in the same industry as the venture, such as a large

supplier, distributor, or major competitor. This is to distinguish it from a sale

to a ‘‘financial’’ buyer, generally not in the same industry, who purchases the

venture for its investment value. In an acquisition, target firm shareholders

can receive cash for their shares, they can exchange their stock for stock in the

acquirer, or they can receive cash or stock for the assets of the company.

When an acquirer purchases the equity of a company, the buyer assumes

both the assets and the liabilities of the target company. In a purchase of assets

only, the price can be relatively lower because the purchaser does not have to

assume the liabi lities of the target firm; this is particularly appropriate where

the acquired firm has the potential for significant legal liabilities. The higher

equity purchase price will provide the entrepreneur with some cash to pay off

the known liabilities, so that the net effect should generally be similar.

In a stock for stock exchange, shares are exchanged based on some

pre-acquisition ratio of value between the two companies. For example, if

Target Firm has a valuation of $15 million and Behemoth has a valuation of

$450 million, shares of Target Firm would be exchanged in proportion to a

30 to 1 ratio—adjusted for differences in the number of shares outstanding.

The advantag e of a stock for stock exchange is that the transaction is not

taxable to the entrepreneur. This advantage may be complicated by any

‘‘vesting schedule’’ under which the entrepreneur holds stock options in the

6

See http://www.entrepreneur.com/Your_Business/YB_SegArticle/0,4621,285394,00.html

Exit Strategies 233