Navigating IPOs and Other Exits for Unicorn Startups
Looking to cash out? Here’s how to exit a startup like a pro investor.
Hitting unicorn status with a valuation of over $1 billion is a big win for any investor backing a startup. But let’s not forget the next step in this journey — exciting investments.
It’s not always easy or predictable, so it’s crucial to analyze and find the best solution that benefits both the investor and the startup. Of course, as an investor, you want to maximize your profit in the short term, but timing can be a challenge.
Exit plans are essential for portfolio success, so the startup’s growth rate and real exit opportunities are what matters to the investor. A key to a successful exit is profitability.
For example, if you invested $300,000 for 10% of the company and sold your stake for $30 million, that’s a 100x return on investment.
Choosing the best method to exit a startup can be overwhelming because each option has pros and cons. In this article, we’ll explore the main ways to make an exit and help you choose the most profitable and safe option as an investor.
Choosing exit strategies
Let’s discuss two ways venture startups can exit the game: IPO or M&A (mergers and acquisitions). According to Pitchbook and Fortune, M&A deals in the US outnumber IPOs by almost ten times. Crazy, right?
Although IPOs are usually the go-to indicator for success, we should be paying more attention to M&A. Corporations acquire startups to strengthen their market position and gain expertise. The startups may generate more profit for the shareholders while getting access to the resources and large customer base of a big company.
Take Github, for instance. It’s the world’s largest web service for hosting and collaborating on IT projects. In 2018 it was acquired by Microsoft for $7.5 billion. Microsoft was interested in attracting 27 million dedicated Github users to its cloud ecosystem.
In some cases, founders will buy out their investors’ shares if they believe in the growth of their startup. It gives them more control over the company, and investors get some return.
Another option is selling the venture investor’s stake to a secondary buyer, like a large venture capital firm or private equity fund. It allows for some liquidity before the company goes public, which can be a plus if the IPO market is turbulent. Secondary sales are becoming more popular with original investors who want to exit their investments and get a return.
Secondary is also attractive to buyers, who couldn’t invest in Series A, but want access to high-growth companies with a decent operating history.
Some startups consider selling from day one. For example, Google founders Sergey Brin and Larry Page were not sure if they need to start a company; they wanted to sell their technology but couldn’t agree on a deal.
Early-stage investors may exit a startup because their expected portfolio returns are no longer appropriate, and they don’t think they will get more in the future. The secondary sale option provides more flexibility and liquidity because it allows investors to withdraw their capital earlier than in a traditional IPO model.
IPOs, simple explanation
When big companies want to make a bank, they can go public through an IPO and sell a part of their biz for big bucks. But for startups, it’s a different story. The process takes a lot of time and money that most early-stage companies can’t afford. Plus, the founders will need financial consultants or underwriters (usually investment banks) to help them.
The IPO process has four stages, starting with the company preparing reports and assessing its financial position, which can take a few years. Then they choose a listing exchange and develop an investment memorandum for potential shareholders. After that, they launch an advertising campaign or roadshow to attract investors.
To make it work, a company should have a great rep and long-term strategy, hot products, or services. But there are always exceptions, like Rivian Automotive, who went public even though they hadn’t started production yet and still raised over $100 billion in market cap.
At this point, experts develop different scenarios for the IPO, like a positive one where the share price rises or a negative one where things go south.
Even large companies have failed IPOs, like Uber, when their capitalization fell by $14 billion on the second trading day due to geopolitical conflicts. Ouch! But if all goes well, companies can make banks, like Saudi Aramco, who made history with the biggest IPO ever in 2019, selling a share package worth $25.6 billion.
Timing the exit just right
So, when is the best time to exit? Well, it’s not an easy question to answer.
Okay, so here’s the deal: founders like to hold off on selling their company until they can make bank, which means startups can be stuck in limbo waiting for a big exit. Meanwhile, buyers want to make a bargain deal: to buy cheap and make big money.
Sometimes, founders manage to keep a decent chunk of their company when they go public, but it is rare. Bill Gates was one of the lucky ones — he still owned 49% of Microsoft after its IPO in ‘86.
The same angel investors end up with just a tiny percentage of the company when it goes public because there have been so many funding rounds. So, if an angel investor put in $500k at a $10 million valuation, owning about 5% of the startup and making 100x, where his investments are now worth $50 million, he might only end up with less than 1% of the company after the IPO.
Sometimes IPOs get delayed because the founders are dragging their feet or because of other factors, such as the economic landscape. It can be a real problem for investors who have all their eggs in one startup basket and want to cash out and move on to the next thing.
It’s like they might be worth millions on paper, but until they can sell their shares, it’s all just theoretical.
And here is a pain: as an investor, you may have the whole net worth on paper of $70 million, but in reality, $50 million of assets are squeezed into one stock because the IPO still hasn’t happened.
So if you are a successful angel who made it through all the challenges of a startup, 80% of your wealth is in one startup. A problem arises, which is called wealth concentration. Frustrating, right?
And as a minority shareholder, you have no say in the matter. In this situation, it is often unclear to the angel investor what to do. So what’s the solution, and how to catch the moment for an exit? There’s no magic formula. You sit there, waiting patiently and looking for the exit door.
Here is a paradox: the more successful your investment is, the more risk you have.
How do you get rid of this risk? Our team of experienced investors from the Unicorn Club will share real cases and stories of the business angels who successfully resolved these problems and exited their startups. Stay tuned!
