How To Reduce Risk With An Effective Exit Strategy
Every entrepreneur who starts a new business has good reason to hope that their new business will be successful, grow, and prosper beyond the foreseeable future. However, any savvy business person knows that 8 out of every 10 new businesses will and do fail. Among many other reasons, one of the biggest reasons new businesses fail is the failure to pull out of a costly venture before critical events bring down the entire enterprise.
Starting a new business means working with the unknown and doing so in an environment that is extremely competitive. Entrepreneurs are creative people whose task it is to carve out an institution where there was nothing before. That means risk is an irreducible feature of the startup business world. It also means that not every venture has to succeed for a business to succeed.
Every startup business owner worth his salt has got to have a viable exit strategy. More than this, he has got to have a flexible exit strategy which can adapt to the reason for getting out when the ship starts to sink. To formulate a viable and flexible exit strategy, it is important to understand all of the numerous reasons a venture may fail.
What we’re looking for here is to develop the foresight to foresee the collapse of a venture, and the clarity to see why we’re getting out and how. For this reason, we will list the many common reasons new ventures fail. Naturally, we should also be mindful of modes of failure that are specific to specific ventures. Unfortunately, we will be limited to the more general ones.
Pinning down the specific modes of failure your venture might be susceptible to is up to you.
11 Reasons to Execute an Exit Strategy
The following are generic reasons to exit a venture or business before debts stack up and recovery becomes impossible. The idea here is that we foresee an impasse before it becomes a disaster from which recovery is futile. As we go through the reasons to initiate your exit strategy, imagine how the given scenario might apply to your business. Your exit strategy will be a method or a timing by which you land your plane safely and walk away… rather than flying into a cliff.
Failure to reach a necessary milestone.
During the early stages of planning and starting a business, you should set forth a number of milestones. These milestones should embody the prerequisites of continuing to do business. An airplane has to achieve a certain speed before it can take off. Milestones are similar to this.
An example might be, a construction contracting business needs to acquire a given piece of equipment- maybe a bulldozer- to function in a given market. If the company does not have the bulldozer by spring of the second year, perhaps it might be wise to initiate an exit strategy.
For most companies, the milestone will usually be monetary. This is just to show that it’s called a milestone, not a ‘wealth marker,’ for a reason.
Failure to access necessary capital for the continuance of operations.
In some cases, capital might be differentiated from milestones. This is simply a bit of nuance. The point is that you not fail to begin your exit strategy if you are flush with cash, but still fail to obtain a necessary piece of capital.
A good example of this might be a building permit, which can sometimes be hard to obtain. Applications can take years to process and city officials can drag things out unnecessarily. If this is the case, litigation might be an important part of your exit strategy- in order to regain lost startup capital.
Lack of necessary skills, requisite approach, or resources.
Many, if not most, businesses depend on key talents being in place. If those talents are not at hand or accessible, a venture may sink like a stone.
A good example is a Japanese restaurant. Such an enterprise would require not just culinary skills, but culinary skills of a specific nature. Without them, you cannot go forward- and a good sushi chef can be very hard to find.
The loss of intellectual property or copyrights.
For any number of reasons, it is possible to lose key intellectual property. This could be menu items, logos, fictional material, or what have you. In many cases, some quick thinking can keep the ship afloat. But the loss of too many key pieces of intellectual property over too short a period of time can irreparably damage a business model.
Suppose McDonald’s was just starting out. Now, suppose they lost the right to use the Grimace character. No problem, right? Then they lose the Fry Guy, the Hamburglar, and Ronald himself. Now, they’re just a mediocre burger joint at best- and it might not be enough to carry the brand.
Harmful interest rate trends.
Every good business model takes advantage of one particular economic trend or another. Quite often, low-interest rates are one of these. On the other hand, high-interest rates might be beneficial to a new financial business. But interest rates are like the wind, and what fills our sails one day, could turn and collapse them the next.
Scalability grinds to a halt.
Hopefully, the inability to grow would not come as a surprise. Scalability is often predictable, but changes in capital access and funding can cut growth potential off at the knees.
Insurmountable changes in tax law.
Just like interest rates, tax laws are often the bedrock on which we set up new ventures. If the ground shifts beneath our feet, we need to have the good sense to make tracks before we begin to sink into the sand.
Legal reasons such as liability lawsuits, a divorce, or estate planning.
Some life events are as disruptive and traumatic as a major illness. A divorce, for example, is the kind of thing that many people errantly attempt to muscle through without scaling back in other areas. Legal difficulty can ruin a business, even if you win your lawsuit, contentious divorce, or what have you.
If any of these severely life changing events come your way, it’s best to divert resources into surviving them as quickly as possible. If that means executing your exit strategy, then that’s what you should do.
Going down with the ship may be romantic, but it’s terminal and unnecessary.
Key partners die, wish to retire, or are disabled and have no heir.
This is analogous to losing necessary skills, requisite approach, or resources. If you lose key people, it could be worse for your business than never obtaining them in the first place. It could mean funerals, estate sales, drastic alterations in personal care plans and more. This parade of horribles could spell the demise of the business, and you should plan accordingly.
Mergers & Acquisitions (M&A)
Selling your business is always a viable part of any good exit strategy. The transfer of ownership to a qualified buyer comes in four basic forms:
- Merger — This is when one organization absorbs another. You and the acquiring company may agree on terms such as whether or not you will continue to manage your absorbed organization. When the merger is complete, the acquiring company will maintain its previous brand and image.
- Consolidation — Here, the two companies join to form a new company.
- Acqui-hire — In this scenario, the purchasing organization takes on key employees as a mass-hire agreement. All other assets can be sold off or traded in a way that is commensurate with the terms of the acqui-hire
- Management Buyout — Here, the management of one company buys a controlling share of your company.
Preparing for an M&A exit means making sure your organization is in a saleable condition. To make the necessary changes, you will need a team with the requisite knowledge, skills, and experience. Experts in corporate law, financial planning, tax law, and wealth and asset management will be key members of your team.
Initial Public Offering (IPO)
A company will typically choose to go public when it has reached specific milestones, when large amounts of growth capital are needed, or when key members are pursuing liquidity.
Preparing for an IPO means obtaining the help of an external IPO team. Such a team will consist of lawyers, CPAs, an underwriting firm, and Securities and Exchange Commission (SEC) professionals. Your IPO team will help you to decide on an offering price, what forms of security you should issue, draft SEC documents, and more.
A well-formed IPO plan takes one to one and ½ years to prepare. Before going public, your company must be reformed as a C corporation and be appraised at no less than one hundred million.
No one can tell you what exactly your exit strategy should be. It depends on your assets, the values of your holdings, what can be sold and how fast. Maybe you have a ready buyer for a piece of property that would be very hard to sell otherwise. In that case, that sale is a key part of your exit strategy.
The idea is that you take the time to develop your exit strategy before you need to. You may want to consult a financial advisor or legal counsel to help develop a set of functional exit strategies which you can set in motion should one calamity or another befall you.