In my two previous posts on angel investing and syndicated angel investing, I write about how to get started with angel investing. At some point, you will probably want to get some money back, though.
Since there is no regulated, public market to buy and sell shares, this can be a bit tricky.
This is a topic that is less discussed. So with this post, I wanted to explore three ways to make an exit: The IPO, The Acquisition, and The Private Sale.
The Initial Public Offering
Filing for an IPO essentially means that a company issues new shares that an investment bank then places in the public markets. Taking a company public requires a tremendous amount of work from the company's part to comply with regulations around public markets and allow for.
The upside is that all this due diligence is that the shares get listed in the public market, which allows private1 and institutional investors (e.g., hedge funds and pension funds) to buy shares in the company.
The IPO is often seen as the preferred way to exit for you as an early investor because you don’t have to sell your shares right away. The fact that the stock gets listed on a public market means you can sell your shares whenever you want to.
You can even choose to sell a portion of the shares and keep the rest. In the case of Google, this would have given you a return of +3300% after the IPO in 2004.
An important point to keep in mind is that when a company goes public, there is usually a lockup period during which pre-IPO investors (including founders and employees) are prohibited from selling their shares. This is done to prevent investors from selling all their shares at the time of the IPO, resulting in a significant drop in price. The lockup period is usually six months but can also be longer.
It’s also the type of exit that takes the longest to realize. Companies are staying private longer and longer2, and it’s not uncommon for unicorn startups to stay private for over a decade.
Finally, depending on how the market sentiment looks, this also may not be a viable option. For example, 2022 was a year with where many companies chose to cancel their IPO plans3. I personally missed out on an exit in early 2022 due to the company canceling their IPO when Russia invaded Ukraine.
An acquisition is when another company buys a majority or (more commonly) all of the shares in the startup. An acquisition is very much a viable strategy and about ten times as common4 as an IPO. The reason why it’s more common is that first of all, you only need to convince one buyer vs. in the case of an IPO where you need to convince hundreds or thousands of investors to buy parts of your company.
In the case of an acquisition, there are two common ways to get paid. A cash payment or through a share swap. Getting paid in shares might sound bad at the start, but trading your shares in a risky startup for shares in something like Google could be a great outcome for you.
Google is a much more stable company than any early-stage startup, and it’s also a public company, which means you get the same benefits as you would in an IPO, usually without the lockup.
There are many reasons why one company would want to buy another, and it has a large impact on the actual price you get paid.
For example, a competitor could realize that your product is significantly better and that it will be both cheaper and easier to buy your company outright than it would be to build a competing product in-house. The recent Figma acquisition is a great example of this, where Figma was bought for a valuation that was 2x the latest round.
The acquihire 5, where the buyer is more interested in the team than in the product itself, is less ideal for you as an investor. The buyer's motivations to incentivize the founding team to stay for as long as possible usually mean part of the deal is new stock options for the founding team and a low price for shares.
Note that if you don’t own a large percentage of the shares (>10%), you probably don’t have a say in whether to sell your shares in the case of an acquisition. First because you will simply be outvoted by larger owners, and second due to the common drag-along clause.
Finally, something that could be straight up bad for you is if any of the larger investors have any liquidation preferences6, as this could prevent you from getting your pro rata. Liquidation Preferences over 1x are not common, but I have seen it in one of my portfolio companies, and I suspect it will be more common as the current downturn keeps accelerating.
The Private Sale
The third common way to make an exit as an angel is through a private sale (also referred to as a secondary transaction). This simply means that you sell your shares to a willing buyer outside of any public market.
This might seem counterintuitive. After all, investing in startups is about investing for 10+ years. But this is precisely the reason why I recommend selling at least part of your stake if you get the opportunity. Taking some risk off the table is smart and serves as protection against both markets and startups turning. It is, as Jason Calacanis puts it, idiot insurance.
I keep coming back to budgeting and planning out your investments. If your plan includes not seeing any returns for at least 10 years, you can afford to be patient. But you can also afford to be a bit opportunistic when it comes to secondaries.
Getting some money back early, even if it’s “just” a 3x return on that money, means you now have the option to recycle that money and invest it in one or more new startups. On the other hand, if your angel investing plan relies on getting money back on a <5-year horizon, then you will most likely end up in a situation where you have to sell. That is never a good thing.
Since you don’t have access to a public market, the main problem with this type of exit is finding a willing and suitable buyer. You could, of course, get lucky and have a VC buy out all smaller investors in conjunction with a Series B or C. But since hope is not a strategy here are some concrete suggestions:
- Ask current investors on the cap table. This might be an option if you have investors there which you know have deep pockets. Depending on when the latest round happened, you might need to give a fairly steep discount (20-50%).
- Find a platform tailored for secondaries. Platforms such as Tioex or Seedrs act as marketplaces for secondaries.
- Ask people you know who invest in startups. Maybe one of your angel investor friends (which you should have plenty of after making a couple of investments) is interested in buying your shares?
The Wrap Up
With that, I hope you have a better understanding of how to turn an illiquid asset into a liquid one. It’s important to understand though that there is no one size fits all when it comes to exit. Everything depends on the company, the markets, and the wishes of different investors.
That said, there is one rule that generally holds true; Great companies are bought, not sold. If you don’t have to sell, you will get a better price. Always. Investing for the long term while being on the lookout for opportunities to get partial returns along the way is how I’ve seen the very best play the game, and it’s also how I navigate the land of startup investments.
Lastly, I would love to hear from other people's experiences with exits. If you have anything to add to what I’ve written here or if you just have a good story to share, please don’t hesitate in reaching out to me on Twitter, LinkedIn, or just by sending me an email at firstname.lastname@example.org.
Until next time!
There is no way the buyer could recruit the founders normally, so they pay a premium to get their knowledge. This is particularly common in the case where the foudners are experts in some domain, such as AI. ↩
After over a decade of building apps, teams and companies, I've now started coaching founders and CTOs through something that I call Nyblom-as-a-Service.
If this is something that would be interesting to you feel free to schedule a free discovery call to see if we are a good match for each other.