Exits 101: Finding Startups with Exit Potential



An exit is your opportunity to cash-out.


After searching for your startup, assessing it, investing, and waiting, an event will come where the company is going to change drastically and you will be able to sell your shares.


This usually takes three to five years, but can take up to 10. Angel investing is a long-term game and requires patience.


This exit event can come in many shapes and forms. This includes Initial Public Offerings (IPO), acquisitions, and even bankruptcy.


Exits You Need to Know

Let’s explore the different types of exits, why they happen, and how they affect angel investors.

Initial Public Offering

The most desirable type of exit is the Initial Public Offering or IPO.


Only companies that have established themselves within a market and garnered significant success and attention can reach an IPO.


When a startup “goes public” it sells shares to the public through investment banks and stock exchanges. Here, any investor can buy stock and become a partial owner.


An IPO is the finish-line for angel investors. This is the ideal opportunity for you to sell your shares and reap huge profits.


When a startup goes public, the early investors stand to make the most money. Because they bought into the company early when the risk was high and the valuation low, their returns on exit are extremely high.


While the returns on an IPO exit are usually the highest, it often takes quite a long time for a company to get there.

Acquisitions

A more common exit event is an acquisition.


If a startup you invested in becomes valuable or competitive within its market, a large company may want to buy it.


The buyer may be interested in the startup’s team, technology, or market share. After some negotiation, terms will be set, and the startup will be absorbed into the buying company.


Because you invested and are a part-owner in the startup, your ownership needs to be purchased too. This is when you can sell your stock in the company.


An acquisition is almost always a great outcome for the angel investor.


Usually, the company’s valuation at the moment of acquisition is much higher than it was when you invested. A high exit-valuation means a big return for you.


While returns aren’t usually as high for an acquisition exit as an IPO, acquisitions can happen very quickly.


It usually takes many years for a company to go public, but an acquisition can happen within a few months of a Reg CF round. This means a faster payout to angel investors.

IPO Via SPAC

A SPAC is a special purpose acquisition company.


SPACs have no commercial operations. They don’t really do anything you would expect a company to do. They are formed for the sole purpose of going public and acquiring another company.


SPACs are usually formed by veteran corporate leaders who intend to pursue acquisitions within their industry of expertise.


Once the SPAC is public, it can acquire a startup, merge the two companies, and change its stock ticker name to the startup's name.


And just like that, a private startup can be publicly traded, skipping over the challenges and timeline of a traditional IPO.


SPACs are an increasingly common exit event—2020 saw more startups go public via SPACs than any other year in the last decade.

Other Types of Exits

There are a few less common types of exits to be aware of. These are usually less desirable than IPOs and acquisitions.


  1. Management buyouts - In this scenario, the founders of the startup buy back all of the shares from investors. This represents an exit moment for an investor who can sell their shares to the new owners.

  2. Sale of secondary shares - In some cases, you will be able to sell your shares directly to another private investor.

  3. Asset sales and bankruptcies - This is the least desirable exit for investors. You may still get a return in the process of the startup's dissolution but will depend on the distribution waterfall.


Shaping Your Investment Around an Exit

Now that you know what kinds of exits to look out for, we can move onto the next step—investing with exits in mind.


Angel investors don’t just give money to interesting companies, we aren’t philanthropists.


Sure, one of the most exciting parts of funding startups is supporting ideas and people that you believe in and having a hand in shaping the future.


However, a profitable exit is always the endgame. Plain and simple—you only invest in a startup if you have a strong belief that it can exit and net you a large ROI.


So, how can you plan ahead? How can you plan investments around exits?


Plan a Timeframe of Returns

How long are you willing to wait and how will you get out?


Angel investing is a long-term game. Most investments will take years to play out. Some investor’s portfolios have no trouble waiting ten or more years for a return, whereas others may need results within five.


Here is what you need to address before investing:


  1. When will you be able to sell your equity?

  2. When do you need the money?

  3. How does this fit into your portfolio?


Ask yourself these questions and make sure you’re ready to play the waiting game.


Studying the startup’s plan can help you to map out a timeline that works for you.


Assessing the burn rate, or how much money the company spends each month, can give you some clues. If in the early stages a startup has an incredibly high burn rate, you might not be getting your money back any time soon.


Understand Your Return Potential

Before going into an investment, you need to know about your return. Know how you will get it, when, and how much. For anyone making many angel investments or managing a portfolio of investments, this is essential.


The truth is, most investments just won't pan out. A good strategy is to do some quick math and see if your potential reward on one startup can cover the cost of multiple losses.


For example, if you make 10 angel investments, make sure that just one startup success can cover the expenses of all of them. You aren’t getting any ROI if you profit a little bit on one startup but lost money overall from your other angel investments.


You should keep track of your actual investment amounts and factor in any fees or costs you paid to take part.


Make an intelligent ROI plan that will cover your losses and expenses. You need to do the math—there’s just no getting around it.


Evaluating a Startup’s Exit Potential

Finding startups that can make it to the finish line is tough. No angel investor can do it every time.


However, you can greatly increase your chances of success by following a few simple guidelines before placing an investment. Think of this as your due diligence checklist.


  1. Assess the management team

  2. Learn about the market

  3. Get inside the head of the target customer

  4. Ask common sense questions


The goal of your checklist is simply to reveal red flags and make sure your startup is set up for success.


Going further, there are some general goals you should keep in mind when conducting due diligence.


Do Due Diligence and Ask Questions

Your first impression with a startup may be a presentation, a listing on an angel investing website, or a recommendation from your investing community. This is where due diligence begins.


Take in everything you can about the product, team, and goals. If the project seems sound and sparks your interest, start by noting any questions and concerns that pop into your head.


Ask, is there something missing? Then distill your ideas down to a few digestible points.


Do some digging and get your answers. You can even take part in live events with founders or contact them through whatever Regulation Crowdfunding platform they use.


Perhaps there is something you need to know about the management team, competition, or financials.


You don't need to go overboard here, just point out the vital issues. Don't worry about the small stuff, those shouldn't break a deal. Be efficient and focused.


Make an Investment Thesis

A great habit to get into is creating an investment thesis. This is like a blueprint of the deal, mapping everything from pitch to exit. This may sound technical, but it's quite simple.