VC firms invest in startups to earn profits from their investments in the future. They put startups through a rigorous screening process to identify and fund the ones with the highest growth potential.
VC firms decide when to exit from their portfolio startups, either to earn the highest possible profits or to cut losses (as not all investments yield profits).
A VC can pursue one of several exit strategies. IPO and M&A are the most common events during which VC firms exit from their investments.
During an IPO (Initial Public Offering), a company lists its shares on a stock exchange. A VC firm can then sell its shares on the stock exchange and realize its return on investment (if any).
M&A is short for Mergers and Acquisitions. Mergers happen when two companies come together to become one. A good example is the merger between telecom giants Robi and Airtel in Bangladesh.
Mergers can happen through purchase, in which Company A purchases Company B and then incorporate Company B’s assets into Company A. Mergers may also occur via consolidation, wherein two firms of equal size agree to unite.
An acquisition takes place when a company buys a controlling stake in another company and becomes the owner of both companies.
Sometimes, some companies purchase their shares back from their investors. This transaction is called a share buyback. So, if a startup founder wants to buy back shares from a VC firm, and the VC firm wants to exit that company, it may agree to sell its shares to the founder. This may happen when a VC firm and the startup founder do not get along, and both parties want to part ways.
When a company cannot repay its debts, it may stop operating and sell off its assets to repay creditors. This is called liquidation. After the liquidation process, any remaining money is distributed among the shareholders. Needless to say, no VC firm wants any of its portfolio companies to face liquidation.
Another way of exiting an investment may be by selling a company’s shares on a secondary market. Before a company goes public, VC firms which provided initial funding may sell off their shares to other investors. This sale takes place in a private equity secondary market as the company’s shares are not publicly listed.
VC firms may also exit a company when their investee company gets acquired by a Special Purpose Acquisition Company (SPAC). A SPAC refers to the formation of a shell company. SPACs are usually founded by investors who have expertise in a specific industry and want to chase deals in that industry. The purpose of setting up a SPAC is to enlist it on a stock exchange to raise money. The investment raised from the IPO is used to acquire or merge with a privately held company. Once the private company merges with the public company, it can start trading publicly. If the SPAC does not merge with a company within two years, it must return the funds raised to its investors.
The private company’s shareholders, including any VC firm which may have invested in the company earlier, can sell their shares off during this time.
The advantage of a SPAC over an IPO is the shorter duration in which a private company can start trading publicly.
Which exit strategy will be chosen by a VC firm depends on its circumstances, including the startup’s performance, the state of the VC firm’s relationship with the startup founder, economic conditions, the profitability of exiting at a particular time, etc.