Why Angel Investors Prioritize Defined Exit Strategies
Angel investors are typically interested in defined exit strategies for several key reasons. These strategies provide clarity, alignment, and confidence in the investment opportunities. In this article, we will explore the reasons why defined exit strategies are crucial for angel investors and share insights from personal experience.
The Significance of Defined Exit Strategies
Angel investors aim to achieve a significant return on their investment, and a defined exit strategy outlines the possible ways they might realize this return. Whether through an acquisition, merger, or initial public offering (IPO), a clear exit pathway is essential. This helps investors assess the potential risks and rewards, making informed investment decisions.
Risk Management and Return on Investment (ROI)
Startups are inherently risky ventures, and an exit strategy helps investors manage these risks effectively. Knowing the potential exit routes, such as acquisitions or IPOs, allows investors to evaluate the possible outcomes. This risk assessment aligns with the investors' expectations of returns, ensuring that both parties are on the same page regarding the investment timeline and potential liquidity events.
Timing and Planning
Angel investors often have a specific timeframe for achieving returns on their investment. A defined exit strategy provides a timeline for these liquidity events, which helps in aligning the investors' time horizon with the startup's growth trajectory. This understanding also enables investors to plan their future investments and financial strategies, ensuring they can adapt to changing market conditions.
Avoiding Disconnects Among Founders and Management
The process of discussing exit strategies can reveal important disconnects among founders and senior management. Some founders might want a quick exit, while others might want to continue the journey for several years. Addressing these differences early on is crucial for maintaining alignment and trust within the team.
Attracting Co-Investors and Strategic Guidance
A well-defined exit strategy can make a startup more attractive to other investors, as it indicates that the founders have thought through their business model and future. This can help in attracting co-investors who share the same long-term goals. Additionally, having a clear exit strategy can guide the startup's growth and operational decisions, encouraging founders to focus on milestones that will make the company appealing to potential acquirers or public markets.
Personal Insights from an Angel Investor
Personal Insights from an Angel Investor
As an angel investor myself, when I ask founders about their defined exit strategies, I am more interested in how they go about answering the question rather than the answer itself. If the founders lack creativity in thinking about a wide range of possible exit strategies, it often indicates that they will lack the creativity to overcome the many operational barriers they will encounter on their growth journey.
The process of discussing exit strategies also highlights disconnects among different members of the founding and senior management teams. Some might want to continue the journey for many years, while others might be more eager for a quick exit.
Most experienced angel investors are aware that the exit strategy pre-investment will probably be totally re-written along the journey. However, pre-investment discussions between angel investors, founders, and senior management allow the angels to structure their offer to achieve alignment where they perceive a disconnect between their objectives and those of any of the founders or other key stakeholders.
Angel investors often want their investment to be protected from founders who never want to exit or from founders pushing for an early exit. Shareholder agreements and incentive schemes are often negotiated to address these concerns. For instance, when we founded our business, our angel investors put in place share option schemes for the founders and management, which incentivised us to get an exit within 5 years.
Realigning Objectives and Trust
After a few years, once we had established a fast-growing and profitable business, our angel investors wanted to be on the journey for as long as possible, after having survived the risky startup phase. We, however, were not looking to exit as we still had so much to achieve. Initially, we didn’t exit soon, and the angel investors decided to restructure our equity incentive plans to motivate us for the next phase of growth.
Eighteen years after starting our journey, we exited to a strategic trade purchaser, and the penny shares we issued at the start of our journey were worth over ￡2 a share, plus the dividends we had been paying over many years. Other angels who wanted earlier exits were able to offer their shares for sale back to the company or pro rata to other shareholders from time to time.
The exit strategy we developed in association with an international investment back looked nothing like the exit strategy our angels had asked us to create all those years earlier, but it did give them the confidence to invest. This strategy helped us achieve alignment and trust between our founders' investment plans and the angel investors, which was maintained for 18 years with periodic realignments as the company and its management grew through each successive phase of growth.