An exit strategy is your plan to leave an investment, ideally by selling it at a higher price than when you purchased it.
Individual investors, venture capitalists, stock traders and business owners all use exit strategies that set specific criteria that will dictate when they’ll get out of an investment. Every exit strategy plan is unique to its situation, in terms of timing, when and under which conditions an exit may occur.
What is an Exit Strategy?
Broadly speaking, an exit strategy is a plan for leaving a specific situation. For instance, the government may use the term “exit strategy” when discussing plans for removing a military presence from a particular location. Or an employee who’s interested in changing jobs may form an exit strategy for leaving their current employer and moving on to their next one.
In a financial setting, exit strategies are plans crafted by business owners or investors that cover when they choose to liquidate their position in an investment. To liquidate means to convert securities or other assets to cash. Once this liquidation occurs, the individual or entity that executed the exit strategy no longer has a stake in the investment.
Creating an exit strategy prior to making an investment can be advantageous for managing and minimizing risk. It can also help with defining specific objectives for making an investment in the first place. In other words, formulating your exit strategy beforehand can give you clarity about what you hope to achieve.
Exit strategies often go overlooked, however, as investors, venture capitalists and business owners may move ahead with an investment with no clear plan for leaving it.
How Exit Strategies Work
Investors use exit strategies to realize their profit or to mitigate potential losses from an investment or business. When creating an exit strategy, investors will typically define the conditions under which they’ll make their exit.
For instance, an exit strategy plan for investors may be contingent on achieving a certain level of returns or reaching a maximum threshold of allowable losses. Once the contingency point is reached, the investor may choose to sell off their shares as dictated by their exit strategy.
A venture capital exit strategy, on the other hand, may have a predetermined time element. Venture capitalists invest money in startups and early stage companies. The exit point for a venture capitalist may be a startup’s IPO or initial public offering.
Again, all exit strategies revolve around a plan. The mechanism by which an individual or entity makes their exit can vary but the end result is the same: to leave an investment or business.
Recommended: What is an IPO? Key Things Investors Should Know
When Should an Exit Strategy Be Used?
There are different scenarios when an exit strategy may come into play. For example, exit strategies can be useful in these types of situations:
• Creating a succession plan to transfer ownership of a profitable business to someone else.
• Shutting down a business and liquidating its assets.
• Withdrawing from a venture capital investment or angel investment.
• Selling stocks or other securities to minimize losses.
• Giving up control of a company or merging it with another company.
Generally speaking, an exit strategy makes sense for any situation where you need or want to have a plan for getting out.
Exit Strategy Examples
Here are some different ways exit strategies can be useful to investors, business owners and venture capitalists.
Exit Strategy for Investors
When creating an exit strategy for investing, there are different metrics you can use to determine when to get out. For example, say you buy 100 shares of XYZ stock. You could plan your exit strategy based on:
• Earning target return from the investment
• Realizing a maximum loss on the investment
• How long you want to stay invested
Say your goal is to earn a 10% return on the 100 shares you purchased. Once you reach that 10% threshold you may decide to exit while the market is up and sell your shares at a profit. Or, you may set your maximum loss threshold at 5%. If the stock dips and hits that 5% mark, you could sell to head off further losses.
You may also use time as your guide for making an exit. For instance, if you’re 30 years old now and favor a buy-and-hold strategy, you may plan to make your exit years down the line. On the other hand, if you’re interested in day trading and short-term gains, you may have a much shorter window in which to complete your exit strategy.
Exit strategies can work for more than just stock investments. For instance, you may have invested in crowdfunding investments, such as real estate crowdfunding or peer-to-peer lending. Both types of investments typically have a set holding period that you can build into your exit plan.
Exit Strategy for Business Owners
An exit strategy for business owners can take different forms, depending on the nature of the business. For instance, if you run a family-owned business then your exit strategy plan might revolve around your eventual retirement. If you have a fixed retirement date in mind your exit plan could specify that you will transfer ownership of the business to your children or sell it to another person or company.
Another possibility for an exit strategy may involve selling off assets and closing the business altogether. This is something a business owner may consider if the business is not turning a profit, and it looks increasingly unlikely that it will. Liquidation can allow a business owner to repay their creditors and walk away from a failed business without having to file bankruptcy.
Exit Strategy for Startups
With startups and larger companies, exit strategies can be more complex. Examples of exit strategy plans may include:
• Launching an IPO to allow one or more founders to make an exit
• A merger or acquisition that allows for a transfer of ownership
• Selling the company
• Liquidating assets and shutting the company down
If a founder is ready to move on to their next project, they can use an IPO to leave the company intact while extricating themselves from it. While angel investors or venture capitalists who invested in the company early on have an opportunity to sell their shares.
Startup exit strategies can also create opportunities for investors. IPO investing allows investors to buy shares of companies when they go public. Buying shares of IPO stock could be profitable if a newly public company takes off.
The mechanics of using an IPO as an exit strategy can be complicated. There are IPO valuations and regulatory requirements to consider.
It’s important for startup founders to know how to value a business before taking it public to ensure that an IPO is successful. And early-stage investors may have to observe IPO lock-up period restrictions before they can sell their shares.
Recommended: Navigating the IPO Lock Up Period
Why Exit Strategies are Important
Exit strategies matter because they offer a measure of predictability in a business or investment setting. If you own a business, for example, having an exit strategy in place that allows you to retire on schedule means you’re not having to work longer than you planned or want to.
An exit strategy for investors can help with staying focused on an end goal, rather than following the crowd, succumbing to emotions, or attempting to time the market. For example, if you go into an investment knowing that your exit plan is designed to limit your losses to 5%, you’ll know ahead of time when you should sell.
Using an investment strategy can prevent doubling or tripling losses that could occur when staying in an investment in the hopes that it will eventually turn around. Exit strategies can also keep you from staying invested too long in an investment that’s doing well. The market moves in cycles and what goes up eventually comes down.
If you’re on a winning streak with a particular stock, you may be tempted to stay invested indefinitely. But having an exit strategy and a set end date for cashing out could help you avoid losses if volatility sends the stock’s price spiraling.
How to Develop an Exit Strategy Plan
Developing an exit strategy may look different, depending on whether it involves an investment or business situation. But the fundamentals are the same, in that it’s important to consider:
• What form an exit will take (i.e. liquidation, IPO, selling shares, etc.)
• Whether an exit is results-based or time-based (i.e. realizing a 10% return, reaching your target retirement date, etc.)
• Key risk factors that may influence outcomes
• Reasons and goals for pursuing an exit strategy
If you’re an individual investor, you may need to formulate an exit plan for each investment you own. For instance, how you exit from a stock investment may be different from how you sell off bonds. And if you’re taking on riskier investments, such as cryptocurrency, your exit strategy may need to account for the additional volatility involved.
For business owners and founders, exit strategy planning may be a group discussion that involves partners, members of the board or other individuals who may have an interest in the sale, transfer or IPO of a company. In either situation, developing an exit strategy is something that’s best done sooner, rather than later.
The Takeaway
Investing can help you build wealth for the long-term and an exit strategy is an important part of the plan. It allows you to decide ahead of time how and when you’ll get out of an exit, and could help you lock in returns or minimize losses.
One step you can take to update your investing plan – including that exit strategy – is to open an account on the SoFi Invest® online brokerage platform. With SoFi Invest, you can choose from stocks, ETFs, and even cryptocurrency to build a portfolio.
Photo credit: iStock/Christian Guiton
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