#19 - Exits, The End of a VC Fund's Journey
How do VC funds achieve liquidity?
Welcome back StartOP family! This week we are taking a deep dive into what it means when a startup “exits”. As you’ll soon learn, there are many types of exits which are often chosen based on the stage and needs of a startup. Make sure to check out our previous articles on the Structure of VC and Stages of VC Funding for some additional background!
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Why are Exits Important?
An exit is the process when shares of a company owned by a venture fund gain liquidity. Exit events usually happen 8 to 10 years after the initial investment which directly aligns with the average lifecycle of a venture fund. After an exit, the company continues developing on their own, and the venture capital firm begins dispersing funds back to investors.
There are four main types of exits: mergers and acquisitions (M&As), initial public offerings (IPO), special purpose acquisition company (SPAC) and stock buybacks/management buyouts (MBO).
Mergers & Acquisitions (M&As, not M&Ms)
This is exactly what it sounds like — companies are either merged into one, or a company buys the full ownership of a startup and pays VC firms for their equity (either in cash or stock of the parent company). M&As are the most common type of exit for a venture-backed startup since larger companies often seek to buy a smaller business to outsource R&D, remove a potential competitor, or acquire proprietary technology. If the startup is not dissolved during a M&A it has the benefits of leveraging the stability, steady growth, and vast resources of a large parent company.
Graphic from UML Business Data.
Stock Buyback/Management Buyout (MBO)
A stock buyback (also often called management buyout or MBO) happens when the management of a startup buys back the ownership of the company from their investors or a VC firm using private equity, personal funds, and revenue. This is often done so a company can be less restricted by the investors' conditions and incentives. It is, however, a rare case among VC exits as the buyouts often require massive amounts of liquid funds.
Nevertheless, rarely doesn't mean never: for example, Buffer spent $3.3M in 2018 to buy out their Series A investors. You can read more about this curious case in their blog.
Initial Public Offering (IPO)
An Initial public offering (IPO) is the process where a private company goes public. A private company only offers ownership to private entities (investors, management, and employees), whereas anyone could buy a share of a publicly-traded company. Companies often go public to access the large amounts of funds held by public markets.
Before going public, a company has to file their IPO with the SEC (U.S. Securities and Exchange Commission) and hire an underwriter. Financial institutions, such as Morgan Stanley or Goldman Sachs, will then bid on the company to determine its value and the initial price of the stock, along with helping distribute the shares when the private company goes public. When the shares are released, public investors can begin buying and selling shares in the company which will determine a companies actual fair market value.
Graphic from Visual Capitalist.
Special Purpose Acquisition Company (SPAC)
A SPAC is an alternative way for a private company to go public by merging with a shell company (aka a blank check company). The shell company effectively only exists on paper and has no actual product. That shell company would then go through the IPO process and becomes a public facing company (by selling shares to go public). Once the shell company, now know as a SPAC, has raised a substantial amount of capital, it can purchase and merge with a private company. This merger causes the private company to go public with the SPAC taking on the identity of the previously private company. Going public through a SPAC has grown increasingly popular due to the lower capital requirements, reduced fees and increased speed compared to traditional IPOs.
Almost every successful company funded by a VC firm will go through an exit at the end of the fund’s lifecycle. An exit from a VC firm's standpoint simply means the company’s equity is converted to liquidity.
There are four main types of exits: M&As , IPOs, SPACs, and stock buyouts. Each exit approach has their pros and cons, and the choice between them depends a lot on the development and goals of a startup and their investors.