It is not always the first thing on the mind of entrepreneurs but understanding some of the basic startup exit issues is a useful way to keep your options open.
When considering a startup exit, usually the entrepreneur’s aim will be to hand over the management to someone else, to capitalize on their investment or to exit both operationally and financially. There may be a variety of exit options available such as simple handover to a successor, a sale, a management buyout (MBO), an IPO or liquidation.
Simple succession plans deserve serious attention but if a founder wishes to transfer some or all of their financial interest; the issues will generally be more complex than just handing over the reins to new management. MBOs and IPOs can be particularly complex transactions.
Considerations for Transferring your Financial Interest in a Startup Business
When transferring your financial interest in a startup, the first consideration is to ascertain what is to be transferred, whether the shares or assets of a company or whether in part or whole. This will obviously vary and will depend on the circumstances and state of an individual business.
The shares in a company or anything that is required to operate the business can potentially be transferred. This may be tangible goods and property such as premises from which the business operates or any plant and equipment used, or it can be the business name, client lists and debtors.
Once it is decided what is to be transferred, the most important thing to determine is value.
If the founder is making a clean exit, the new management of a business may wish to insert a non-compete clause in the contract to prevent them from opening a similar business. The restraint will usually be limited to a specific time period and geographical reach.
In some circumstances new management will want to have a training period, where the founder or his team teaches them how to operate the business. Such training may take place before or after completion and vary in length; usually between seven and 28 days.
Putting a Startup Exit Strategy in Place
Entrepreneurs wishing to exit from startups need a strategy in place early on. If the business has several different shareholders, a shareholders agreement is the proper place to outline exit objectives and routes.
One aspect that needs to be thought about is the amount of cash drawn out as remuneration during the life of a business. While it may be tempting to draw large sums of money regardless of company performance, doing so can have negative tax implications and may also use up funds that are needed further down the line for growth, limiting its future value.
Liquidating a Business
Where entrepreneurs wish to simply liquidate a business, it must be borne in mind that proceeds from the assets will have to be used to repay creditors, with the remainder being divided between shareholders.
While liquidating is quick and involves no negotiations or transfer of control, it is not the best means of getting the most value out of the business. Parts of the business such as goodwill, the business name and client list are not recoverable.