AC6108: Venture Capital
and Private Equity
Topic 3.1 Creating, Managing and
Exiting Investments – The Exit
13/03/2025 AC6108 1
Harvesting: The Exit
Learning Outcomes
• Understand how investors plan their exit strategy
• Recognise exactly how investors time their exit
decisions
• Appreciate the different choices that investors make
between different exit routes
• Differentiate between the pros and cons of different
exit routes
The Importance of Exit Markets
• VC and business angels are buy-and-sell investors who look to exit their
investments hoping to realise a return
Business angels are often less exit-centric than VCs – they invest with their own
money and do not have a duration restriction (i.e. life-span of the fund).
• Entrepreneurs have longer horizons
• The returns from venture capital and private equity investments flow as
capital gains to the Limited Partners once the investment has been terminated,
rather than through ongoing dividend returns.
• VCs’ investment decisions are partly determined by the potential for a
timely exit, as it enables them to realize their returns (Pearce and Barnes,
2006; Cumming, 2008).
Not all investors systematically develop an exit plan. Many assume that, once
they’re ready to sell, a buyer will be available to purchase their shares. This can
result in poor exit decisions.
How will they
get their money
back?
Exit Routes
• Initial Public Offering (IPO)
• Acquisition (trade sales)
• Buyouts
• Shutdown and write-off the investment
What will impact the exit timing & value
• Company specific factors
• Deal characteristics
• Macroeconomic factors
• Term sheet requirements from VC/PE investor
• VC/PE’s value-adding services
Plans can change over time
Potential Exit Actual Exit
Why should an entrepreneur consider financing options with their exit strategy in mind?
[Link]
Exit routes in the United States.
Panel A: Exit routes in the United States (number of deals).
Panel B: Exit routes in the United States ($ billion).
Exit routes in Europe.
Panel A: Exit routes in Europe (number of deals).
Panel B: Exit routes in Europe (€ billion).
Distribution of VC exit value in 2021, by exit rout
Europe: venture capital exit value by route 2021 | Statista
Espenlaub, Khurshed and Mohamed (2015a) – VC Investments and Global
Exits
• Sample: UK VCs exited during 1990–2010
• Findings:
A successful exit is more likely when a VC syndicate includes an experienced
member
The likelihood of a successful exit is high in countries with, and at times of, high
stock market liquidity
The likelihood of a successful exit is high in countries with more efficient legal
systems (e.g. some systems provide more investor protection).
• Interesting one:
M&A is more frequent to exit UK investments than those abroad, while the
probability of an IPO is substantially higher for investments outside the UK.
It might be due to the difference in the legal systems, but there is a potential
selection bias – VCs only decide to invest abroad when they are confident about
the investment.
Or is the result driven by the US observations?
Initial Public Offering
• IPOs are the most profitable exit route
Chaplinksky and Gupta-Mukherjee (2010) examined
US exits from 1985-2008 and found
Mean exit return for acquisition = 99.5%
Mean exit return for IPO = 211.7%
IPOs account for 67% of the top quartile of returns (home
runs) and 24% of bottom quartile (strikeouts)
Achleitner et al (2012) looking at North American and
European exits from 1982-2008 also found IPOs
perform better than acquisition
2024 IPO Market: [Link]
• Advantages of IPO
For the entrepreneur - normally remain in control
For investors – high returns, VC reputation
• Disadvantages of IPO
IPO only offers a partial exit
Lock-up agreements
High transaction costs
Suitable for profitable and larger firms
Need to comply with on-going disclosure rules
Plus other disadvantages of being a public company (e.g.
underpricing, control dilution, price volatility, being targeted in
hostile acquisitions, disclosing info to competitors)
Acquisitions
Is the firm being bought or is
it trying to sell …… big
difference!
The 13 Biggest Mergers and Acquisitions ([Link])
[Link]
Acquisitions
• Full exit for the investor and the entrepreneur
• Investors can get business brokers to groom the business, search for
possible acquirers, and manage the sale
Objective: get the highest price
• Payment can be cash (preferred) or shares of the acquiring firm
May use earnout (base price + % of base price when conditions are
met)
• Terms to be considered:
continued employment of founders and key employees,
how to deal with outstanding employee stock options,
non-compete clauses that prevent the founder and key employees from
working for competing firms for a certain period of time,
specific liabilities and
the use of intellectual property
• Once price and terms agreed
Acquirer starts due diligence
Exclusivity agreement put in place
Escrow account set up (usually for one year) to hold
percentage of sale price to hedge against unexpected
claims against the business such as incomplete litigation and
contingent liabilities
• Advantages of acquisitions exit
Potential full exit
Transaction costs are lower than IPO
• Disadv of acquisition exits
Entre loses all control to the acquirer
Entre may have different exit objective than investor but might have
agreed to grant the investors tag-along or drag-along rights
Valuations paid on acquisition exit tend to be lower than IPO exits
Brau et al (2003) report a 22% illiquidity discount on acquisitions
when compared to IPOs in US
The quality range of ventures exit with acquisition is wider
Acquirer normally conducts extensive due diligence and is more
knowledgeable about the firm and what it has to offer. This reduces
information asymmetries and lowers the likelihood of overpricing.
Entrepreneurs opt to sell to a larger firm, recognizing that remaining
independent might jeopardize their survival in a competitive product
market (self-selection effect)
M&A 2023: [Link]
Buy-outs
• Investor sells their shares to another investor, the
management (the entrepreneur) and/or employees
• More popular in EU than US
• Advantages of Buy-outs
Allows investor to exit in part or completely while the entre
retains control
Entre or management team can increase their ownership
of the firm (and they can use personal bank debt to support
this)
If employees are involved, then they become part-owners
and will then have strong incentives to work harder
Firm could buy back the exiting investors shares; known as
leveraged recapitalisation
Company borrows the money to fund the shares
Purchases shares
Then cancels the repurchased shares
Benefit:
Interest paid on debt is tax deductible
Drawback:
May increase debt burden on the company thus may impact
liquidity and solvency ratios and in turn access to finance and future
profitability
• Disadvantages of Buy-outs
Do not have the most attractive price (with a pecking order
after IPO and acquisitions)
Special-Purpose Acquisition Companies
• [Link]
• [Link]
Write-offs
• Poor and moderately performing investments find it
difficult to use other exit routes
• Some of the investment can be recoupled by selling
assets
• In EU write-offs accounted for 20% of total number
of exits during 2007-2015 period
Exit Route Choices
Timing
Timing Exits
• Quicker successful exits are beneficial, and it can be a
performance indicator of VCs
• In US VC hold their shares
For a median of 7 yrs before exiting via IPO
For a median of 4 yrs before exiting via an acquisition
• VC exit decision depends on
Success of the venture
Characteristics and actions of the investor
Price that shares will fetch
• Angel exit decision is less organised
They are more patient when making exit decision
Important Factors
Geographical Whether it is in Silicon Valley?
location of the Does the country have an efficient legal system with good investor protection?
portfolio company Is it far away from the VC’s location (or even cross-boarder)?
Industry/sector of
the portfolio Biotech and ICT sectors are usually faster
company
Stage of
development of
The later the stage, the closer it is to IPO or M&A
the portfolio
company
Achievement of
A sign of quality
milestones
Increases the pool of contacts
Syndicate size Enhances certification
Increases performance through greater added value
VC experience Better investment selection and value adding
However, younger VCs might rush to exit for reputation (Gompers, 1996) – grandstanding hypothesis
Macro-economic
conditions Market liquidity determines the speed of finding a buyer
• Giot and Schwienbacher (2007) - IPOs, trade sales
and liquidations: Modelling venture capital exits using
survival analysis
• Analyse investment duration for 6,000 US venture
backed firms that together had 20,000 investment
rounds between 1980 and 2003
• Findings
Later-stage investments, syndicated investments and ventures that received
follow-on investment rounds have faster exits
These tended to be more successful ventures that had achieved
(technological) milestones and developed more quickly because of the
complementary value-adding services provided by multiple VCs
partnering in the syndicate
Improved stock market conditions speed up exit decisions
• Felix et al (2014) - The exit decision in the European venture capital market
• They examined the time to exit of European VCs
• Findings:
More intense monitoring by the VC leads to shorter investment decisions and
faster exits
In Europe, venture capitalists associated with financial institutions have quicker
exits
VCs with pre-planned exit strategies at the time of the investment achieved
faster IPO exits in Europe
The presence of VC on the board of directors leads to longer investment
durations
• US VCs that engage in more on-site monitoring of ventures were also
able to achieve faster and more successful exits (Bernstein et al. 2016)
Espenlaub, Khurshed and Mohamed (2015b) – Venture
Capital Exits in Domestic and Cross-border Investments
• Sample: UK VCs exited during 1990–2010
• Findings:
Cross-border investments are exited more quickly than
domestic investments, and this difference is driven by the
cross-border investments in North America
Market liquidity and legality speed up the time to IPO exit.
M&A exits are speeded up by higher stock market
valuations and GDP per capita slows down the time to exit
for both M&A and IPO.
Investors and Successful Exits
• Choice of exit route is driven by perceived quality of the venture
• A pecking order exists, but it is possible to have two exit routes
simultaneously or sequentially (in so-called “dual-track sell-outs”), which
tends to generate higher premiums (Brau et al. 2010)
• More experienced VCs and entres are more likely to generate a successful
exit (Axelson and Martinovic, 2015)
• VCs with more industry specialisation and more active involvement make
more successful exit decisions in EU and US
• Dimov and Shepherd (2005) showed that VC fund management teams with
better specific human capital and consulting experience were less likely to
face a write-off
• Investors need to be able to handle info problems in exit markets
IPO works best if you can easily value the firm (Cumming and Johan,
2008)
Acquisition works better when higher info asym vis-à-vis public investors
The IPO Process