Due diligence for an early stage investment

How should you review a company exit plan?




3 min read

“Investing in a company is easy, getting out of one is much harder.”


There are a large number of reasons that individuals get into angel investing but by far the most common reason that people get involved is to achieve a financial return on their investments. And, given the nature of the asset class and the risk involved, the potential returns sought need to be large enough to cover this risk. Just how an angel can expect to get their money back will be outlined in the companies exit strategy but, be warned, exit strategies are one of the easiest parts of the business plan to get wrong. Below we highlight the key details you should spend time questioning when it comes to a company’s exit plan.

 

  1. What type of Exit are they planning for?
    While there are a number of additional ways that an exit can be achieved, the big three investors are interested in are a trade sale, an IPO, or recapitalisation which can be done through a management buyout, dividends, or private sale of shares by any shareholder.

    Trade sale - the most common type of exit in the US and Europe. Trade sales entail the disposal of a company's shares or assets and even liabilities – in whole or in part – to a strategic or financial buyer. Effectively the company is bought out by another company or another group of investors.

    Initial Public Offerings (IPOs) – an IPO occurs when a privately held company goes through the process of listing shares on a publically traded market such as the London Stock Exchange (LSE) in the UK or the New York Stock Exchange (NYSE) in the US.

    Management buyout – As the founders of a company move on the wave of management may wish to buy the current shareholders out of their position. This is known as a management buyout and usually involves the raising of debt plus an equity injection from external investors.

  2. How long do they think it’s going to take?
    A general rule of thumb is to double the time the company thinks it will take to exit. While you should hope that they can stick with their business plan and deliver on the timescale they say, there are multiple outside factors that can impact on their ability to sell.

  3. How big do they believe their exit will be?
    Start by looking at the exits of companies similar to the one you are considering investing in. If they have all exited for a much smaller figure than what the company you are looking at is hoping for, you should bare that in mind. Very few companies will reach even a £100 million valuation so make sure what they are saying is realistic.

  4. Market Conditions (http://nvca.org/research/exits/)
    The market for company sales and IPOs is cyclical and generally tracks that of the wider economy. If a company is expecting to sale / IPO in the next few years, have a think about where the wider economy will be at that point in time.

  5. Potential Competition and Intellectual Property (IP)
    There are often a number of businesses competing within a space and the one that get’s the best exit is not always the one that you would think. There are a number of factors that make a company an attractive target and if there is lots of competition within the space you need to understand what the competition could offer potential suitors. One way of making a company stand out from the competition is the Intellectual Property that it owns. Many acquisitions have been made where the IP owned is the main motivation for the purchase.

  6. Do they have a back-up plan?
    Things can and do go wrong so it’s good to know what a company plans to do in the event that the planned exit does not materialise when or how it was expected. Private companies can issue dividends just as easily as publically traded companies so don’t rule this out as one way of giving back to the investors if there is a change of plans to the exit.

As always, investing in early stage ventures is risky. Even the best formed exit plans can go wrong and even the brightest young ventures can go bust. To read more information on investing in early stage ventures have a look at the recommended articles below.

 


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