Regardless of what stage your startup is at, you may have thought about ways to eventually exit it. Common ways include merging with or selling your startup to another company, doing an IPO, or transferring your ownership to successors. What is the legal process for each of these ways, and how should you plan ahead? This article will discuss exit planning.
Merging With Or Selling Your Startup
There are several considerations that need to be made early on if your goal is to eventually merge with or sell your startup to another company.
Upon a merger or a sale, preferred shares convert to common shares, and if your investors have a high liquidation preference, you could end up with very few proceeds from the transaction. A liquidation preference is the ratio of proceeds that an investor receives compared to you. It is important to negotiate the terms of liquidation with your investors even at the early stages so that you do not run into this problem later down the road.
Mergers and sales require board and shareholder approval. If you are diluted both at the board and shareholder levels, you may find it difficult to push through with a merger or sale if other board members or shareholders do not want it. There are several ways to avoid this conflict:
- Make sure to only onboard directors and investors who have the same exit vision as you.
- Make your shareholder agreement bulletproof so that you can drag dissenting investors onto your exit plans.
- Negotiate with investors so that they agree to purchase preferred shares that come with very few or no voting rights.
Doing an IPO
An IPO will involve a significant structural change to your startup. Private companies can mostly operate how they want, but public companies require ongoing financial reporting and the fulfillment of other obligations. The valuation of your startup will change based on matters outside of your control, and every big decision made by your management team will be subject to public scrutiny. Successful IPOs happen when companies plan beforehand for these changes. In order to persuade your board and shareholders to approve of an IPO, you will need to organize your business in a way that can maximize the chances of success post-IPO.
Now, how would you do this? The best way is to run your business like a public company before your become one. Stay on top of audits, even if they are not required. Good audits can increase the valuation of your startup even before you do any official valuations. Prepare your startup for public scrutiny and market winds by keeping operations transparent and establishing a core business that is somewhat recession-proof.
Transferring Your Ownership To Successors
This is the easiest way to exit your startup. Private transfers do not involve as much hassle as mergers, sales, or IPOs. Board and shareholder approval is easier to obtain because private transfers are somewhat more individual as opposed to affecting the entire company. While directors and investors obviously care if the incoming shareholder is a nutcase, as long as your successor has decent business acumen, most approvals go through.
What steps are involved? First, you need to check your formation documents to see what is needed for a transfer. You may need to file for a securities exemption with the Securities and Exchange Commission or comply with other shareholder restrictions. An example is the right of first refusal, which requires you to offer your shares to existing shareholders on the same terms as those you are offering to your prospective buyer. If you are looking to exit generally, you may not care about who exactly is buying your shares, but you will need to follow this procedure. Then, you will need to prepare a sale and purchase agreement containing the terms of the sale.
What’s Next?
Business plans for startups constantly change, so you do not need to plan your future exit in perfect detail until when you begin considering it seriously. Nonetheless, there are operational habits that you can adopt beforehand “just in case.” For example, performing regular, high-quality audits can increase the valuation of your company regardless of which exit option you choose. And, in addition to legal planning, you may want to speak with an accountant to go over the tax implications of each of the options discussed earlier. A good accountant can structure your audits and the dates of your business milestones in a way that can reduce taxes when you actually go through with an exit.
