Business Inside Out by Martin Towers: Why an exit strategy is needed from the start

Take private equity, who typically will invest in a business with a three to five year time horizon. At the outset this timing cannot be guaranteed and who knows what the external environment might look like then. But one of the first questions their investment committee will ask is how do we make a successful exit from this investment.

Private equity are generally found backing growth companies so there will be the reasonable prospect that with the company growing, profitable and well run, that an exit one way or the other can be achieved.

Take the start-up growth business that has proved viable with the backing of family, friends and crowdfunding or a variation of that theme. It is quite likely the participants have gone into the relatively risky venture with an eye on the exit and a suitable reward for taking the early stage equity risk. And hopefully there is a lucrative exit as opposed to discovering the business was not viable and has run out of cash. The backers of start up businesses may be prepared for successive rounds of investment beyond the initial investment, but can get fatigued if there are too many and beyond their means to support.

The Enterprise Investment Scheme (EIS) has encouraged many U.K. entrepreneurial start-ups and requires a minimum holding period of three years. The hope will be that a deep pocketed and larger buyer will emerge who can provide the additional resources to allow the business to continue to flourish and realise its potential.

Investors in smaller public companies also have the exit issue to concern themselves with. Many companies outside the FTSE350 are relatively illiquid. For a small company there are not a lot of shares to buy or sell so a limited market. An institution may be unable to acquire what it regards as a meaningful stake. In exiting there would be a problem finding a buyer for their stake without depressing the share price.

Few outsiders are promoting the shares and the investment case. The share price has a low rating and is likely to stay that way. These companies find it difficult to attract new investors. And some of the existing investors find it difficult to exit, so might start lobbying the company to get me out of here by putting itself up for sale thereby enabling an exit in full all in one go, and at a premium.

Family owned companies may also face the exit issue but through a different set of potential problems. Problems arise with family members not involved in the business who would rather sell out and have the cash to spend. The next generation may not be willing or able to carry on running the business and there is a succession planning issue. The former situation can cause almighty family bust-ups while the latter is more manageable and likely more predictable as to outcome.

Martin Towers is the former finance director of Kelda Group, which was the parent company of Yorkshire Water, and former CEO of Spice PLC. He is now an early-stage business investor.