Exit strategies explained

Last updated: 26 June 2024. 

Startups – what are they heading for? Startup founders often plan for an exit, such as a merger and acquisition (M&A) or initial public offering (IPO). But exit strategies are relevant to all shareholders, including shareholders created through share schemes, as they enable them to realise the value of their shares. 

In this article, we will explore the main types of exit strategies available to business owners and discuss the pros and cons of each.

The main types of exits

1. Private sale

A trade sale involves selling the company to a third party, often another business in the same industry, a strategic acquirer, or a private equity (PE) company. It's one of the most common and straightforward methods of selling a business. 

A survey found that over half of startups expect to be acquired. It can happen pretty fast too; some businesses are acquired within less than one year, though the average is more like five years.

Private sales tend to fall into one of two categories: 

• Trade sale
  
  Typically involves a merger or acquisition (M&A) initiated by another company. The business is partly or fully sold to a third party.
  
  
• Sale to PE firm
  
  Involves selling part of the business to a PE firm acting on behalf of investors, who back the business and provide capital for it to progress. This can still lead to a trade exit in the future. 

Trade sale

Broadly speaking, a trade sale provides a clearer-cut exit, allowing founders to depart from the business in the immediate term if they wish.

However, they may retain the option of managing the business as part of the acquiring company. 

✅ Pros:

• Maximising sale price 
  
  A trade sale often results in the highest possible sale price for the business owner, as the buyer may be willing to pay a premium for strategic advantages, such as intellectual property or market share.
  
  
• Clean break 
  
  Selling the business to a third party allows for a clean break from the company, giving the owners the freedom to pursue other ventures.

❌ Cons:

• Finding a buyer
  
  The process of finding a suitable buyer for the business can be time-consuming and challenging, especially in niche industries or competitive markets.
  
  
• No control post-sale 
  
  After the sale, the former owner loses all control over the company, which can be difficult for those who put their heart and soul into building the business.

Selling to private equity (PE)

On the other hand, selling to a PE firm unlocks liquidity and allows a business to upscale its operations while remaining under the same control.

However, ownership is diluted by the PE's stake, and they’ll likely have a say in decision-making – though they should support founders rather than totally take over. 

In addition, the PE buyer can provide the capital the business needs to grow while decreasing its risk exposure, as might be the case with reinvesting hard-fought revenues and profits. 

In other words, it’s someone else’s money on the table – that gives budding businesses some much-needed liquidity and strategic breathing space to grow and develop.

✅ Pros:

• Maintain control
  
  Founders keep control of their business, including strategic and operational decisions. The team's vision is what the private equity firm supports.
  
  
• May support better future outcomes
  
  Private equity excels at supporting transformative changes, such as large acquisitions or international expansion. This is backed by expert advice to guide the business toward favourable future outcomes. 

❌ Cons:

• Shift in ownership
  
  While founders and management can stay at the helm, the PE still owns a stake in the business, and their visions may not precisely align with what the founders originally had in mind.
  
  
• Protracted process
  
  While selling to a PE unlocks some of the business’s liquidity, it might not be the hard and fast break founders and management are seeking. Instead, it may be the start of a long-term process, and that requires the right level of commitment.

What happens to share schemes?

Depending on the terms of either a trade sale or sale to a PE firm, exit-based options can be exercised and converted to shares. 

Shareholders can typically sell their shares to the new business (in the case of an M&A) or become shareholders in the new company. 

If the PE is acquiring more than 50% of the business, then it might not qualify for tax-advantaged schemes in the future, such as the Enterprise Management Incentive (EMI). 

2. Management buyout (MBO)

An MBO involves selling all of the company or some of the company to the existing management team. Buyers typically combine forces to buy the business, often with the help of external financing. The original owners can then step down from the business. 

This exit strategy allows the current management to maintain control of the business and ensures the continuity of operations.

Depending on the terms of the agreement, exit-based options can be exercised at MBO and converted to shares. Shareholders can typically sell their shares to the new owners or remain shareholders in the company. 

✅ Pros:

• No need to find a buyer
  
  An MBO eliminates the need to search for a buyer, as the management team is already familiar with the company and its operations.
  
  
• Business control left with current management
  
  The existing management team is likely to have a vested interest in the company's success, ensuring that the business continues to thrive under the existing culture and leadership. 

❌ Cons:

• Financing 
  
  The management team may struggle to secure the necessary funds for the purchase, potentially delaying or jeopardising the exit process.
  
  
• Skills and expertise
  
  Management teams equipped for MBOs have likely worked for the business for some years but may not have ownership experience. 

3. Employee-owned trust (EOT)

An EOT involves selling your company to an employee-owned trust (EOT). The trust will own a percentage of the company and get the same percentage of company profits. EOTs are a form of indirect ownership. 

This exit strategy is ideal for preserving the legacy of the business, and employees can receive tax-advantaged benefits from business profits. 

Depending on the terms of the agreement, exit-based options can be exercised when the business is transferred to the EOT, and shareholders can sell their shares to the trust.

Ownership through trusts like Employee Ownership Trusts (EOTs) and direct stock ownership via share plans, such as EMI, can coexist. 

A company can adopt a "hybrid" model by becoming an EOT while also offering direct ownership. 

Learn more about employee ownership structures.

✅ Pros:

• Preserve business legacy
  
  By selling to an EOT, the owner ensures that the business remains in the hands of the employees who helped build it, preserving the company's culture and values.
  
  
• No need to find a buyer
  
  Similar to an MBO, an EOT eliminates the need to search for a buyer.
  
  
• No Capital Gains Tax (CGT)
  
  Provided that a controlling interest is sold in one transaction, the sale to an EOT is exempt from CGT.

❌ Cons:

• Takes time to set up
  
  Establishing an EOT can be a lengthy process involving the creation of a legal trust, appointing trustees, and transferring ownership.
  
  
• Deferred sale price
  
  Typically, the sale price is paid over several years, which may not be ideal for owners looking for an immediate cash payout.

4. Staggered step back

A staggered step back involves gradually diluting ownership and control of the business by selling shares and delegating responsibilities. This approach allows for a more gradual transition and leaves the door for a future exit open.

Exercisable options can continue to vest as control is relinquished. 

✅ Pros:

• Maintain control and decision-making
  
  The owner(s) continues to have a say in the company's direction and decisions during the step-back process.
  
  
• Handover of ownership and responsibility
  
  A staggered step back allows for a smoother transition of ownership and control, reducing the risk of disruption to the business.
  
  
• Keep options open
  
  By gradually stepping back, the owner retains the option to pursue other types of exit strategies in the future if desired.
  
  
• Continued income/dividends
  
  The owner can continue to receive income or dividends from the business during the staggered step-back process.

❌ Cons

• Continued involvement
  
  The owner remains involved with the business, which may not be ideal for those looking for a clean break.
  
  
• Unclear progression
  
  A staggered step back should be planned and structured so employees understand what’s going on, as this will affect their decisions. 

5. Initial Public Offering (IPO)

An IPO involves making the company public by listing its shares on a stock exchange. This allows the owners to access public capital markets and gain widespread credibility.

IPOs are what many founders dream of, but they’re relatively uncommon. For example, there were only 422 IPOs in Europe in 2022, and that was the best year for IPOs since 2011.

Exit-based options can be exercised at IPO and converted to shares. Shareholders can typically sell their shares to the new owners or remain shareholders in the company. Shares become worth the public trading price.

✅ Pros:

• Access public capital markets
  
  Going public can provide a large influx of capital for the company, enabling it to fund growth and expansion.
  
  
• Increased company valuation
  
  Publicly traded companies often enjoy higher valuations, which can result in a significant financial reward. 
  
  
• Public awareness
  
  While many major and well-known companies don’t go to IPO, IPO raises public awareness and boosts credibility. 

❌ Cons:

• Complex process
  
  Taking a company public involves a complex and lengthy process, including regulatory compliance, audits, and extensive legal and financial underwriting.
  
  
• Large undertaking
  
  An IPO requires significant time, effort, and resources, which can be a drawback for owners looking for a straightforward exit strategy.

The relevance of exit strategies for share schemes 

Exit-only option schemes can be exercised after an exit event. They can be combined with time or performance-based vesting too.

Exit events are defined in the option agreement and usually consist of:

• A significant change in control
• A company buy-back
• A management buy-out
• A merger with another company
• An asset sale
• Listing on a public exchange
• The acquisition of your company by another entity

Exit-only options can be exercised upon the exit event and sold to the new owners – that’s pretty straightforward.

The business's future value will affect the potential profit shareholders make if/when they sell their shares or exercise their options.

But what happens to other option holders, e.g. those with exercise-based options that aren’t vested upon an exit event? 

Understanding the impact of an exit event on options

When an exit event takes place, the option holders might have the opportunity to exercise their vested options.

Accelerated vesting means all the options in the grant will become available for exercise upon an exit event.

Where the option agreement specifies that the option holder cannot exercise all their options, the unexercised options will lapse.

In the case of an M&A, the acquirer can migrate share schemes to the new business. 

Choosing an exit strategy

Choosing the right exit strategy for your business depends on various factors, such as personal goals, the size and structure of your company, and the industry it operates in. 

It's essential to carefully consider the pros and cons of each exit strategy and select the option that best aligns your business objectives. Of course, this may change as time goes on.

Share schemes and exit strategies interact in many ways – so it’s crucial to consider the impact of any exit on existing options and shareholders.

We've simplified the process of issuing shares and options and setting up vesting schedules with the future in mind. To learn more, book a free, no-obligation consultation.