Venture Capital Exit Rights (2024)

FAQs

Venture Capital Exit Rights? ›

Exit rights comprise clauses related to initial public offerings, including demand rights and piggy-back rights, as well as to trade sales, such as drag-along rights, tag-along rights, and pre-emption rights.

Venture capital exits are pivotal events not only for investors but also for the portfolio companies themselves. They represent the culmination of early faith and financial backing, offering a pathway to return capital to shareholders and stakeholders.

Exit rights refer to clauses within transaction documents such as the Shareholders' Agreement (“SHA”) which grant investors the contractual right to decide on the disposal of their securities in order to Exit the company (“Exit Rights”).

The VC model is a tool that startup founders and investors can use to help determine a company's exit value. The model takes into account a number of factors, including the amount of money invested, the size of the market, the growth rate of the company, and the expected return on investment.

Bear in mind, however, that VCs operate for the sole purpose of generating a return on investment by way of a successful exit. These, in turn, come in many different shapes and forms. The three most popular are: sale to an industry investor, sale to private equity, and going public (IPO).

Most VC exits (especially in recent years) are realized when portfolio companies are acquired by larger, often public, cash-rich companies. In an acquisition, one company buys another, taking a controlling stake of its share and the rights to the assets.

According to data from 2022, for IPOs the average exit timeline was 5.1 years after securing their first VC investment. Several factors can influence the time it takes for a venture-backed company to exit.

Exit Value

In the Venture Capital method, this is usually calculated as a multiple of the company's revenues in the year of sale. Since thismethod is often used to value early stage, pre-revenue startups with negative cash slows, EBIT multiples are usually not applicable.

There are three traditional exit routes for private equity investors – trade sales, secondary buy-outs and initial public offerings (IPOs).

What are the rights of exit? ›

An important aspect of shareholder protection is their exit rights. In a public company, an unhappy shareholder can sell his shares on the stock exchange and exit the company. However, it is not so easy for a shareholder to dispose of his shares in a private company.

Maximising Value: An exit plan helps business owners and investors maximise the value of their investment by strategically timing the exit, optimising the company's financials, and attracting the right buyers or investors.

If a shareholder wishes to sell its shares, the shareholders' agreement will usually include “pre-emptive rights” so that existing shareholders are offered the opportunity to buy shares before third parties are able to buy the shares.

Exit Strategy: Venture capitalists aim for an exit strategy, which could be an initial public offering (IPO), acquisition, or merger. This is when they realize a return on their investment, often reaping substantial rewards if the startup is successful.

Initial public offerings (IPOs) and M&A exits are the two most common means of achieving liquidity in a private company.

An exit is when a venture capitalist sells their stake in a portfolio company, either to another investor, to the public market, or to the company itself.

The Impact on the Investors

If the startup fails, they will not only lose their original investment but also any potential returns that they might have earned had the startup been successful. If the venture capitalists are unable to recoup their investment, they will be forced to write off their losses as bad debt.

Angel investors have several exit strategies, including a sale to another company, an initial public offering, or a buyout. Each exit strategy has its advantages and disadvantages, and it depends on the industry, the company's growth prospects, and the overall economic environment.

In venture capital, a “close” or “closing” happens when a fund has legally secured commitments from Limited Partners (LPs) for a target portion of the intended total fund size. These commitments represent pledges from LPs to contribute specific amounts of capital to the fund.