The limited life of venture capital funds means that entrepreneurs of venture capital-backed companies need to have a clear route to exit.
Having a harvest or exit goal provides strong impetus and a strategic focus to create value in the business that can result in a capital gain to shareholders, the entrepreneurial team and employees. There are societal reasons as well for seeking and building innovative ventures that provide exit opportunities. Innovations and technological advances brought to industries by these companies contribute to new jobs, substantial returns to stakeholders and economic growth.
Successful entrepreneurs plant the seeds of renewal and reinvestment. Such serialization of entrepreneurial experience, talent and capital preserves the march of innovation and the entrepreneurship revolution.
An overview of the main harvest options is as follows:
Initial Public offering
The sale of the company’s shares in a public offering is often the preferred harvest option. Public capital markets generally offer the highest valuation for the company’s shares, and provide initial as well as subsequent (secondary) capital needs of the company. Furthermore, a public offering increases public awareness of the company and enhances the company’s branding and marketability of its products and services.
Although a public offering preserves the company and management’s independence, stock exchange regulations on lock-ups and share offer restrictions mean investors and the entrepreneurial managers can take several years (after an IPO) to fully exit from the company.
Merger, acquisition and strategic alliance
Most financial investors view an outright sale for payment in cash or marketable securities as attractive as the exit ends their involvement with the company. On the other hand, the key entrepreneurial managers are likely to be locked up for several years through employment contracts, often also losing management independence. Hence, depending on the goals and circumstances of the entrepreneurs, this option may be potentially unwelcome by entrepreneurial managers.
Mandatory Share Redemption
This is an exit option which is sometimes available to financial investors. It is based on a contractual right of the investors’ shares to put their shares to the company for redemption or to the entrepreneurs of the company to buy back. This right is available to the investors at the end of, say 5-7 years from the time of initial investment. It is an exit mechanism when the company fails to achieve high capital returns but is reasonably cash-rich or capital rich to redeem the investors’ shares.
The timing of a harvest strategy can make a significant difference in potential exit valuations and capital returns for the company’s stakeholders: entrepreneurial managers, employees and investors. Selling at the right time involves meeting a window of opportunity, and no doubt, it is worthwhile for entrepreneurs and investors to think about harvest issues and strategy at the early stages of venture development.
Some guidelines when crafting a harvest strategy include:
- Patience – Innovative ventures need several years to develop and build up valuable franchise. A harvest strategy should be allowed to take at least 5-7 years or more to fruit.
- Valuation expectations – Behavioral economics describes the endowment effect which is the fact that people place a higher value on a good that they own than on an identical good that they do not own. Closely inked to loss aversion, these behavioral biases affect valuation expectations of entrepreneurs and investors alike. It is therefore important to maintain objectivity in order to keep harvest valuation expectations realistic.
- External advice – It is worthwhile for an entrepreneur to work with an external advisor early and over time shape and implement a strategy to spot and respond to harvest opportunities when they appear. The external advisor might help maintain objectivity and provide the transactional skills to maximize the harvest opportunities.