Before you go in front of a venture capital firm, are you ready to explain your exit strategy with them? Venture capital firms are particularly interested in this portion of your long term plan. The exit strategy is simply the way that the venture capital firm will “cash out” its investment at the end of the investment term.

Venture capital firms know that start up financing is not a short-term investment. It is a high-risk, long-term venture, but the rewards are also high if the venture is a success. Indeed, venture capital companies know that they could lose their capital investment in a company as many as seven out of ten times.  However, the few start ups who make it are worth the payoff.

How will your start up’s exist strategy pay off for the venture capital firm?  They already expect to wait between five and 10 years to get their money out, but after that time, the venture capital firm will want to receive money or marketable securities for their trouble.

Subsequently, if you do not have a viable exit strategy, a venture capital firm is not likely interested in making the investment.

What are possible exit strategies? Here are the most common:

• IPO – An Initial Public Offering, or IPO, is the point where a new start up company takes their business public on the stock market. They offer marketable securities in the form of preferred and common stock. The venture capital firm will usually be a major part of an IPO, with a preferred stock holding in your company.

• Merger or Acquisition – An IPO is not always an option. Instead, a small start up may look to be acquired or merged with an existing larger corporation. The buyout will supply the funds to pay back the venture capital firm.

• Reorganization and Recapitalization – Sometimes a small business start up may take longer to achieve success, but the VC still wants its money back.  Therefore, in some cases, it may be necessary to reorganize and recapitalize through other investments in order to pay back the VC and continue with the product research or market saturation process.

• Liquidation – In actuality, the majority of new businesses that receive venture capital start up funding will fail. Your exit strategy, though hopeful for the best, should also plan for the worst with a liquidation plan if the venture does not succeed.

Venture capitalists are not interested in slow-growing businesses. Take heed of their advice and be ready to present a viable exit strategy when you approach a venture capital firm for funding.

Part of a good business plan is a plan for exiting the business.  Indeed, even you, the entrepreneur, should have a plan for your business where you will no longer be running it.  If you are looking for venture capital funding, having an exit strategy is even more critical.  Remember, venture capitalists receive the most profits when an exit strategy is realized, such as an IPO or acquisition. 

But what is an exit strategy, and how does one conceive of a sound and strategic exit strategy?

An exit strategy is the plan for an entrepreneur or business owner to exit the business.  An exit could take one of many forms.  The business could be sold, all assets could be liquidated, or the business could go the public investor route with a public stock offering.

Liquidate the Business

Some entrepreneurs form a business with the intention of short term gain rather than a lifetime job and income.  Growing a business to end up with a large equity balance on the balance sheet may be the right strategy for a young entrepreneur who has bigger dreams and ideas.  Once the business hits the equity goal, all assets could be sold and debts paid, leaving a nice profit for the entrepreneur.

Likewise, a business that fails is likely to go this route as well.  If an entrepreneur exhausts all means of trying to keep the business breathing to no avail, the liquidation option may be the best exit strategy to get out without further losses.

Sell the Business

Rather than calling it quits and selling the business assets, an entrepreneur could make an exit strategy to sell the business to an interested party.  This strategy may be good for an entrepreneur who also does not want a long-term commitment to the business, but desires to make a profit from his or her efforts.

Selling a business could either be to another entrepreneur who wants to run a business for himself.  Or it could be a strategy to become acquired by a larger business.  Many small business entrepreneurs have gone this route.  YouTube, for example, was formed by former PayPal employees and was subsequently acquired by Google for $1.6 billion – which is not a bad exit strategy.

Opt for an IPO

The initial public offering (IPO) of a company is what many entrepreneurs aspire to accomplish.  A successful private business that has shown growth and revenue expansion can be highly desired by investors.  By offering the business as a public stock company, the entrepreneur releases his or her ultimate hold on the company and puts it in the hands of a board of directors.  The entrepreneur could stay on as CEO or simply cash out his share of stock options.

Whatever the exit option, a successful entrepreneur will have a plan.  The exit strategy is particularly important if an entrepreneur wishes to obtain seed money from a venture capital firm.  The VC wants to know the ultimate plan for the entrepreneur before investing large sums of money.  Thus, it is important that you develop a sound exit strategy plan for your business.  Though it may not be the ultimate result, it still gives an entrepreneur an alternate goal with the business.