BY MMVN Jayanth VS Rao
Every company, and the shareholders, investors or even the promoters, will eventually observe a position wherein the investors of the company seek an exit from the company. It might be for realising profits, personal factors, financial requirements, or other reasons, which makes exit strategy a crucial aspect for both the company and the shareholders. Exit strategies support the company to consider its future and the investors to realise their value of the investment. Therefore, an exit strategy cannot be understood purely as a contingency plan for the shareholders, but as an integral part of policy for the company to further its growth and part of the strategy for the shareholders to realise the value for their investment.i
It is important to understand that all the exit strategies have significant impact on the stakeholders of the company. The change in ownership and/or leadership impacts the employees, customers and other shareholders, which makes it important for the company and the divesting shareholder to negotiate an exit strategy that would not be detrimental for the operations and growth of the company, and be profitable for the divesting shareholders at the same time. A well-balanced exit strategy would cater to the long-term objectives and expectations of both the Company and stakeholders involved. Planning an effective exit strategy would not only maximizes the value of the returns gained by the divesting shareholder, but also ensures the company to continue its operations sustainably with minimum disruptions.
Exit strategies provide a smooth transition for the divesting shareholders to exit the company, liquidating their investments, while leaving the operations of the company to continue without many hurdles. The structure, method and timing of the exit strategy shall be carefully decided analysing the various factors affecting the company, including the size, growth probability, financial performance, and the expectations of the shareholders. The most crucial element for the company to consider should be the goals of the divesting shareholder. There exists a wide array of exit strategies, which the divesting shareholder can opt from and the maximum profitability levels depends on the success of such strategy and the timing of the strategy.ii Understanding these exit strategies would assist the company, divesting shareholders, and other stakeholders in choosing an effective exit strategy.
POTENTIAL EXIT STRATEGIES FOR THE INVESTORS
1.) Offer For Sale through Public Offer. Public offering of securities is when any private or listed company, as the case may be, desirous of raising further funding to expand business operations, issues new and/or existing securities for subscription in the primary market (Initial Public Offer) or the secondary market (Further Public Offer). The price at which the securities are issued for subscription is determined through a pricing mechanism influenced by various market factors such as market conditions, underwriters, valuations, and forecasts. Generally, any company would aim to set a significantly higher price than the price at which the shareholders or investors have purchased those securities. Further, when the demand for these securities increases in the market, the price also sees a significant spike, providing these shareholders with a profitable return on their investment and an option to offer their share through offer for sale. The market, thus, becomes a very lucrative exit option for divesting investors or shareholders to get out of the company and gain profitable returns. However, the market does not promise these returns for every investor, as there is an inherent risk of market volatility.
2.) Liquidation. Liquidation of a company becomes an exit option for the investors when the company voluntarily goes into liquidation after clearing the debt owed by the company. This strategy ensures that the company’s assets and profits are free from any encumbrances and that their market value is realised and distributed equally amongst the company’s shareholders. The directors and shareholders of the company shall decide to liquidate the company based on the performance, financial status, and the market conditions surrounding the company. It is essential to understand that, generally, companies do not choose liquidation as an exit option since the promoters, investors, and other shareholders may not have the same intentions concerning the money invested.
3.) Employee or Management Buyout. A corporate restructuring strategy, where the shareholders sell their stake to the existing employees or the company’s management. This strategy allows the shareholders to exit the company while transferring ownership and control over to the employees or management, who already possess an intricate knowledge of the company and its operations. This exit strategy is desirable for the management or employees who believe in the company’s growth and want to keep it running while the company’s shareholders are looking to reduce or divest their stake. Although this strategy does not provide profitable returns to the shareholders, it provides an option to liquidate the stake of the shareholder who is not happy with the company’s performance.
4.) Secondary Sale. A sale executed by the shareholders of a company, wherein the shareholders sell their stake to a third party who is not related to the company in any way or involved in any acquisition of securities in the company. The secondary sale allows the shareholders to liquidate their stake while not diluting or increasing the stake of the other shareholders. Hence, this gives the shareholders an exit option to leave the company or sell a part of their stake, wherein the price may be negotiated between the parties, typically serving as an early exit option compared to a offer for sale. It is pertinent to note that these sales are often subjected to approvals and restrictions from regulators, other company shareholders based on the shareholder’s agreement.
5.) Strategic Sale. The sale of stakes by shareholders to a strategic buyer could potentially assist the company in expanding its operations, diversifying the market share, or enriching the company’s performance. Typically, strategic buyers are willing to acquire the stake in the company for a significantly higher price, as they anticipate even significant returns from the company post the sale. Other company shareholders generally approve such strategic sales, as they offer premium valuations of their securities, expand synergies of the company, and have a considerably quicker exit timeline. However, the success and profitability of such strategic sales depend on the effective synergy created between the company and the strategic buyer. The higher the synergy, the higher the returns for the company and the divesting shareholders.
6.) Mergers and acquisitions. Mergers and acquisitions, also serve as an effective exit option for shareholders, which involves merging two or more entities to form another entity or acquisition by another entity. This potentially serves as a platform for all the shareholders to sell their control over the company to the merging or acquiring entity. These are particularly appealing for companies performing well or seeking expansion, as the merged entity or the company will transform into a more efficient and growth-focused entity, allowing existing shareholders to expect profitable returns. The divesting shareholders also get noteworthy returns on their investments, as the value of these securities can be negotiated at the will of the divesting investor. However, mergers and acquisitions face numerous challenges, together with cultural misalignment, time-consuming, regulatory implications, and loss of control, amongst others. Hence, mergers and acquisitions provide a profitable exit option, but the success of which is not certain.
7.) Acquihire. In acquihire, the company is acquired for the talent and employees rather than the company’s products, services, or other assets. This allows the company’s investors to exit the company while safeguarding the employees of the company, that they are still provided with employment. This becomes an effective exit option for the shareholders of small companies or startups, as the workforce is the primary asset of such companies. Through acquihires, this asset increases the profitability of divesting shareholders’ stakes.
8.) Sale to the existing shareholder. Often, the shareholder’s agreements executed by the investors and the company’s promoters have various restrictions, such as the right to the first offer, right to first refusal, and drag-along rights. These restrictions require the company’s existing shareholders to be prioritised over any third party or outsider in case of any new issuance of securities, sale of any stake of shareholders or equal opportunity to sell their stake to outsiders. This strategy also becomes a lucrative and profitable exit strategy, as the divesting shareholder may seek a price significantly higher than the market price of the securities. The existing shareholders shall buy the securities for the price offered by the divesting shareholders, or the divesting shareholders have a right to sell it to other third parties, ensuring that the divesting shareholders realise profitable returns for their investment.
9.) Legacy. Legacybecomes a crucial element driving companies to keep the company’s control within the family, ensuring that siblings, children, or spouses take control of the company. This strategy not only provides an exit to the existing related shareholders who want to transfer such control but also to the other existing shareholders who can exit the company by selling their stake to such a related party. In any circumstance, the divesting shareholder would realise significant profits over the investment made, as the family would want to keep control of the company, making it easier to negotiate a favourable price for the divesting shareholder.
10.) Buy-Back. Companies which have excess cash reserves, financially strong and are confident about the growth of the company, to decrease the outstanding shares in the market may call for buy-back of securities. This provides the shareholders willing to divest from the company an extraordinary opportunity to exit the company while trading the securities for a favourable price. The price generally would be issued at a premium than the price of the securities at the market, making the investment of the shareholders profitable. However, this is at the discretion of the company, making it less as an exit strategy in character.
HOW TO CHOOSE AN EXIT STRATEGY?
All the exit strategies, have their particular advantages and dis-advantages, making it challenging for the company, and the divesting shareholders to select from. Considering the stage of the company, industry that the company is involved in and the goals of the divesting shareholder, could assist the company and the divesting shareholders choose the suitable potential exit strategy. Once, an exit strategy is chosen, timing the execution of such exit strategy becomes the most significant decision made by the company and the divesting shareholders.i Timing the exit early could affect the maximum profitability for the investors or if the exit is delayed for too long, then the investment could become illiquid without any potential buyers.
Throughout the operational cycle of a company, whether the company is an early-stage startup, well-established company, or a listed entity, the potential exit strategy keeps varying. An early-stage company would focus on maximizing returns, capturing the growth, and protecting the culture surrounding the company’s operations, as the company cannot offer all the kinds of exit strategies. In contrast, the more mature company would be financially stable, enabling them to offer all the kinds of exit strategies. Further, the company would choose an exit strategy, which leaves the company in a much more financially and operationally stable position.
Investors would prioritize having more immediate liquidity for their investment, smoother exit from the company, and realising considerable profits. Each such investor shall have different objectives, whether to maximise the short-term profits, while securing the financial security, or to maintain a smaller stake in the company’s future. Some investors would want to divest a portion of their entire stake in the company, ensuring that they can participate in the company’s future. Some other investors would want to liquidate their entire stake in the company seeking complete exit from the company. In such situations, understanding the personal goals, risk tolerance, and the furutre financial aspirrations of such divesting shareholder would assist in navigating an optimal exit strategy.
The legal implications and the strict regulatory regime play a guardian role for any exit strategy, making it crucial to navigate during an exit. Investors often face legal implications because of the structure of the company, impact on the stakeholders, the nature of the exit strategy, or restrictions from agreements. These factors place a restriction on the investors ability to divest from the company, making it essential to avoid any complications that could diminish the value of the investment. Therefore, when an investor is selecting an exit strategy, the investor shall evaluate multiple factors, including the stage of the company, sectoral environment, type of the industry, shareholders goals, market conditions, and legal implications. It is essential for any divesting investor to choose an exit strateg carefully, that is appropriate for both the company and such divesting investor, ensuring that the risks are minimized and profits maximized.
[1] ‘Exit Strategy – an Overview | ScienceDirect Topics’ <https://www.sciencedirect.com/topics/economics-econometrics-and-finance/exit-strategy> accessed 25 November 2024
[1] ‘What Is a Business Exit Strategy? Definition, Types and Uses | Indeed.Com’ <https://www.indeed.com/career-advice/career-development/exit-strategy> accessed 25 November 2024
[1] ‘Offer for Sale (OFS): Meaning, Benefits and Working’ <https://www.bajajfinserv.in/what-is-ofs> accessed 25 November 2024
[1] ‘Business Liquidation as an Exit Strategy | Wolters Kluwer’ <https://www.wolterskluwer.com/en/expert-insights/liquidation-as-an-exit-strategy> accessed 25 November 2024
[1] ‘Options for Getting out of Your Business | Wolters Kluwer’ <https://www.wolterskluwer.com/en/expert-insights/options-for-getting-out-of-your-business> accessed 25 November 2024
[1] Ibid
[1] ‘What Is an IPO Exit Strategy? A Detailed Roadmap for Success’ <https://www.linqto.com/blog/ipo-exit-strategies/> accessed 25 November 2024
[1] ‘8 Business Exit Strategies – How to Choose Your Strategy | Ansarada’ <https://www.ansarada.com/business-exits/strategies> accessed 25 November 2024
[1] Ibid
[1] Ibid
[1] Supra, Note 5
[1] Surabhi Kumari, ‘Buy-Back on Shares and Securities’
[1] ‘Exit Strategies: A Key Look’ <https://www.investopedia.com/investing/understanding-exit-strategies/> accessed 25 November 2024
