Investing your hard-earned money to support a startup during its earliest growth phases is a high-risk, high-reward strategy. If however, you’ve dreamed of supporting the trajectory of the next Amazon, or want to help an established business reach its next level, investing your money could be a smart move.
Likewise, you may invest in a partnership, owning a stake in the business but practising full or limited control. In the UK, partnerships represent 7.9% of all firms, making it a popular structure.Whatever your arrangement, one part of it must be your exit strategy because, without one, you are leaving money on the table.
What is an exit strategy for a partnership?
Partnerships allow you to play a more active role in a business without allowing it to take over your life. This type of investment represents a considerable part of the UK economy, with Q4 2022 investment showing a 13.2% year-on-year increase.
Regardless of your partnership, an exit strategy defines how you will exit that partnership. A good strategy details the processes you will undertake for different exits. Some of these exit types include the following:
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- Initial Public Offering (IPO)
- Mergers
- Selling your stake
- Management buyouts
- Liquidation
No matter which exit strategy makes sense for you, an exit plan is designed to help you extract the maximum value for your shares or limit how much you lose if your partnership doesn’t go according to plan.
When should a business partner have an exit plan?
Partners should establish an exit plan at the earliest possible juncture. In many cases, it makes sense to have an exit plan before signing the documents to create your partnership to prevent disputes later.
However, if you have yet to formulate one, it’s never too late. For example, Forbes says that if you plan on selling up, you should have a detailed exit plan no later than three years before the date of your intended sale, but we would even recommend way sooner than that.
To conclude, you should have an exit plan as soon as humanly possible.
What is a good exit strategy for investors?
Investors typically have limited control, if any, in the running of the businesses in their portfolio. They hold a stake and accept their share of the profits/losses, but they are free to liquidate their investments whenever they choose.
From an investment point of view, several options exist for exiting an investment. Some of these strategies include:
IPO – Companies that issue their shares to the public for the first time offer a massive opportunity for investors. This is often the point where they can cash out their investments. In some cases, receiving recompense in the form of shares in the new publicly traded firm may make sense.
Acquisition – Investors can cash out their shares whenever a more prominent company acquires a business. This is a positive conclusion to investment because it provides a quick return on investment and ensures the startup will not fail.
Secondary Market Sales – Some types of investors, such as angel investors, may have the option of selling their shares via a secondary market. This could be a private exchange or an online platform enabling the buying and selling of shares in private companies.
Liquidation – Most investors will have a stop-loss to ensure they don’t lose their entire investment. Once this trigger has been hit, investors may look into selling their shares to a friendly buyer, allowing themselves to be bought out by a founder, or cashing out via the open market.
Beware that liquidating your stake in a sole partnership or a private limited company isn’t as simple as it sounds. If a company isn’t reaching its projections, you could find yourself with a largely illiquid asset.
What is a good exit strategy for business partnerships?
Dissolving a business partnership is less straightforward because there are rules surrounding partnership agreements to be aware of.
Before discussing some of the legalities of exiting a business partnership, what are the best exit strategies for partnerships?
Sale of your interest
The most straightforward option is to sell your partnership interest to a third party. It could be via a private sale or public offering to a known party or someone independent. Moreover, you don’t have to sell your entire partnership interest at once. You could also sell a portion of your interests to a new investor.
Make sure there are no rules mandating that you require the agreement of your partners before you can sell your interest as a whole or in part. Attempting to do so without discussing it could sour your business relationship.
Redemption of partnership interest
Redeeming your partnership interest is also a type of sale. The difference is that you are requesting your partner(s) to buy out the interest in your partnership.
This has the obvious advantage of keeping the firm in the hands of the founders. Likewise, it potentially puts the business on a firmer footing for future success. Finally, it’s quick. Usually, the matter can be resolved in a matter of weeks.
In contrast to selling your interest to someone else, a partnership redemption could mean accepting a lower sale price. Furthermore, it has the obstacle of requiring sufficient liquidity from your partner(s) before you can pursue this exit strategy.
Initial public offering (IPO)
In the best-case scenario, your partnership could become an overnight success, and you find yourself preparing for an IPO. If you’re lucky enough to be a partner in one of these types of businesses, deciding to exit the business could potentially set you up for life.
These exits however, are rare. For example, in 2021 alone, the London Stock Exchange (LSE) saw just 126 IPOs go through.
However, if this happens, partners can sell their shares on the stock market and exit the partnership.
Get Acquired
Being acquired by another company as a small business allows partners to receive cash, stock or a combination of the two in exchange for their partnership interests. Most acquisitions usually lead to a premium for partners in a business.
On the other hand, mergers and acquisitions also require considerable work to go through. Numerous mergers fall before the final hurdle, leading to massive disappointment.
Liquidation
Liquidation of a partnership allows for assets to be sold and all proceeds distributed to partners based on their percentage stakes.
Typically, liquidation also means the end of a business because the UK doesn’t view partnerships as legal entities like limited companies. This is why most partnerships also allow for unlimited liability for all partners.
Naturally, for liquidation to occur, it will require the consent of everybody involved and is the most common exit strategy for both failed businesses and when partners have irrevocable differences.
Preparing an exit strategy for investor exits
Investors are looking to make a financial return; therefore, they rarely have the emotional attachment that a founder might have.
For this reason, the first step to determining an exit strategy is to decide on your financial goals and evaluate the prospects of the business. For example, if you believe a startup has everything it needs to end in an IPO, your exit strategy will have this in mind.
You also must consider the worst-case scenario. Your risk tolerance will become critical to determining how long you’ll stomach an investment loss before departing.
If you’re struggling to outline your exit strategy, here are some factors to consider:
Goals – What do you want to gain from this investment? Write down your desired ROI in percentage terms.
Timeline – How long are you willing to wait for your investment to turn positive?
Risk – What is your tolerance for risk? Can you handle a 50% drop in your investment?
Business Potential – Sometimes, a business idea just hits right. If you’re confident in a business’s long-term prospects, outline your desired metrics to trigger an exit.
Liquidity – For any investor, you must consider your liquidity. For example, the 1% rule outlines that you’ll exit an investment if you are losing 1% or more of your total liquid net worth.
As a business investor, it’s vital that you think about the above factors before deciding on the correct exit strategy for you.
The legalities of exit strategies for investors and partnerships
All partners and investors can have pre-conditions attached that may prevent them from exiting a venture anytime they want. While many investors, such as angel investors, are free to sell their shares at will, the same cannot be said for all types of investments, which may have conditions making them resemble something close to a partnership.
On the other hand, formal partnerships will include details outlining in which circumstances a partner can choose to leave. In the UK, all partnerships are governed under the Partnership Act 1890. Any clauses, such as requiring the consent of all partners or giving a minimum amount of notice, must be respected, or it could lead to legal action later.
If attempting to exit a partnership, it’s vital to consult a solicitor with experience in managing partnerships and unpicking the complexities of these agreements before attempting to create an exit plan.
Either way, both investors and partnerships should seek professional advice when defining their exit plans. At Hilton Smythe, we have the team you need to provide objective advice on creating exit plans, managing existing ones and ensuring that your current plans are fit for purpose.To learn more about how we can support your exit strategy, schedule your consultation call today.