Early Exit (Startup) - Explained
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What is an Early Exit?
An early exit simply means for owners of a startup entity to leave the business by selling their ownership. It is early, because the exit takes place before the owners intended. It is generally a strategic decision based upon the startups situation.
An early exit strategy may refers to a contingency plan that is applied by angel investor, venture capitalist, business owner, or trader to liquidate financial assets to safely exit from the market.
The main purpose of an early exit is to take advantage of earlier-than-expected gains or to minimize possible losses. An early exit strategy can also be used when the firm is not generating the desired profit or a firm has reached the target and now wishes to sell to an acquirer.
There are many other reasons which can push a firm to execute an early exit strategy. For instance, market conditions are fluctuated, or catastrophic events occurred, or legal cases etc., may lead to liquidation.
What to Expect from an Early Exits
Some of the things to expect or plan for in an early exit are as follows:
Time frame - The early exit can be fast and quick, or it may take few years to complete the whole process.
Risk Mitigation - An early exit can be utilized to minimize risk as risk is inherited in business and anything can happen in the market such as market trend can change, natural disaster may occur, new competitors may enter into market, or new regulations may be imposed which can badly hurt the firms profitability.
Contingency Plan - A business or business owners that fail to develop a contingency plan or early exit strategy subjects themselves to unnecessary risk. So the best strategy is to develop and have an early exit plan and decided upon a target. Once the target is achieved, an early exit strategy should be executed. In case firms wait more in the hope to achieve more gains may suffer losses.
Diversification - Angel investors generally adopt and execute early exit plans. They have many investment choices. They will want to undergo an early exit if they may earn more profits in another venture. For instance, an angel investor can reinvest profit in many financial assets and in this way they mitigate risk by diversifying investment.
Always Have an Early Exit Strategy for Traded Securities
An early exit strategy is pivotal for investments in financial securities. It can be applied to both short term and long term investment and for both profit and loss targets. For instance, an investor may set a price per share at which to sell her holdings. Once the share price reaches that target, it is the time to execute early exit strategy. This mitigates the risk of the shares dropping by forgoing the opportunity to benefit if the shares go higher.
Academic Research on Early Exits
- Strategicalliances,venture capital, andexitdecisions inearlystage high-tech firms, Ozmel, U., Robinson, D. T., & Stuart, T. E. (2013). Journal of Financial Economics,107(3), 655-670. We study the trade-offs that biotech start-ups face in the private equity market when they choose between raising firm-level capital from venture capitalists or project-level capital from strategic alliance partners. This paper shows the importance of alliance partners in resolving information problems of capital acquisition, and possible Conflict of Interest between different sources of private equity. It also shows the impact of both alliance activity and VC activity on future activities.
- A cross-country comparison of full and partialventure capital exits, Cumming, D. J., & MacIntosh, J. G. (2003). Journal of banking & finance,27(3), 511-548. This paper considers the issue of when venture capitalists (VCs) make a partial, as opposed to a full exit, for the full range of exit vehicles. To achieve a result, samples on both full and partial exits from a survey of Canadian and US capital firms are used for emphasis.
- Preplannedexit strategiesinventure capital, Cumming, D., & binti Johan, S. A. (2008).European Economic Review,52(7), 1209-1241. This paper empirically considers the role of preplanned exits, legal conditions and investor versus investee bargaining power in the allocation of cash flow and control rights in entrepreneurial finance. We were able to draw different conclusions on a sample of 223 entrepreneurial investee firms financed by 35 venture-capital funds in 11 EU nations. More details can be found in the article.
- IPOs, trade sales and liquidations: Modellingventure capital exitsusing survival analysis, Giot, P., & Schwienbacher, A. (2007).Journal of Banking & Finance,31(3), 679-702. This paper examines the dynamics of exit options for US venture capital funds. Using a sample of more than 20,000 investment rounds, we analyze the time to IPO, trade sale and liquidation for 6000 VC-backed firms. This paper aims to highlight the necessary factors which leads to an increase in exit rates.
- Exitoptions in corporatefinance: Liquidity versus incentives, Aghion, P., Bolton, P., & Tirole, J. (2004). Review of finance,8(3), 327-353. This paper provides a first study of the optimal design of active monitors' exit options in a problem involving a demand for liquidity and costly monitoring of the issuer. The paper spells out the conditions under which more or less liquidity is warranted and applies the analysis to shed light on common exit provisions in venture capital financing.
- The second'equity gap':exitproblems for seed andearlystage venture capitalists and their investee companies, Murray, G. (1994). International Small Business Journal,12(4), 59-76. This paper investigates one element of the relationship between early stage venture capital investors and their larger, development capital counterparts.
- Survival of the Fittest or the Fattest?ExitandFinancingin the Trucking Industry, Zingales, L. (1998). The Journal of Finance,53(3), 905-938. This paper studies the impact of capital market imperfections on the natural selection of the most efficient firms by estimating the effect of the prederegulation level of leverage on the survival of trucking firms after the Carter deregulation. It also highlights the various factors that affect the survival chance for firms in this industry.
- Intergroup predictors of older workers' attitudes towards work andearly exit, Gaillard, M., & Desmette, D. (2008). European Journal of Work and Organizational Psychology,17(4), 450-481. This study investigated the role of intergroup processes in older workers' attitudes towards work and early exit from the workplace using data from 152 45-59 Belgian workers. More details is given in the article.
- Strategic alliances, venture capital, andexitdecisions inearlystage high-tech firms, Ozmel, U., Robinson, D. T., & Stuart, T. E. (2013). Journal of Financial Economics,107(3), 655-670. This articles studies the effect of strategic alliance (particularly those between venture capitalists and company founders) affect the decision to sell or IPO in early-startup technology ventures.
- Private equity returns: An empirical examination of theexitof venture-backed companies, Das, S., Jagannathan, M., & Sarin, A. (2003).Journal of investment management,1(1), 1-26. In this paper we examine 52,322 financing rounds in 23,208 unique firms, over the period 1980 through 2000 by venture and buyouts funds and estimate the probability of exit, time to exit, exit multiples and the expected gains from private equity investments.
- Theexitstructure of venture capital, Smith, D. G. (2005). UCLa L. Rev.,53, 315. This article explores the different provisions regulating exits by venture capitalists. The author aims to examine these exit provisions by use of original data collected from 367 venture-backed companies.