Why You Need an Angel Investor Exit Strategy Before You Invest

Why do you need an angel investor exit strategy graphic

An angel investor exit strategy may very well be the most crucial piece of angel investing.

After all, getting a return on your investment (ROI) is the main point of angel investing. And having an exit strategy in place when you become an angel investor is a great way to ensure you'll see a proper ROI.

Making money as an angel investor can be exciting, but it also has its fair share of risks. About 90% of startups don't achieve success, which means even some of the best angel investment opportunities may not always pan out.

This steep failure rate is an indication of how important it is for you to capitalize most on the companies you invest in that make it to an exit.

An exit is when an angel investor sells their equity in an investment.

The goal of an exit is to recoup the initial investment and then some. Most angel investors seek a return of at least 30% on their initial investment.

Therefore, having an exit strategy in place when you make your angel investment is crucial to setting you up for that return.

There are many ways you can see gains on your angel investment depending on the exit. It is best to have your ideal return on investment and angel investor exit strategy mapped out so you can find a startup that has the same goals as you.

There are many types of exit strategies that may happen. We'll examine each one below.

Let's get started.

Different Types of Exit Strategies

Different types of exit strategies for angel investing graphic

There are six main ways an angel investor successfully exits from investing in a startup company.

No. 1: Acquisition

A frequent exit strategy involves another company buying the startup. In most cases, an acquisition exit generates a handsome return on an angel investor's initial investment.

No. 2: Merger

Like an acquisition, a merger exit strategy is when another company buys a startup to merge it with its existing organization. On average, both acquisitions and mergers tend to be positive exit strategies for investors.

No. 3: IPO

IPO stands for initial public offering. This investor exit strategy is when a startup goes public by offering its stock for purchase on an exchange, such as the Nasdaq. Few companies make it to an IPO, but those that do produce significant returns for angel investors.

No. 4: VC Buyout

Sometimes, a startup raises money from venture capitalists (VCs) after initially taking a seed investment from an angel investor. In some cases, the VCs offer to buy out the angel investor, which may result in quite a substantial profit for the angel investor.

No. 5: Management Buyout

A less frequent exit strategy startups sometimes pursue is a management buyout (MBO). This type of buyout occurs when a company's executive team combines their resources to buy back the equity or assets that have been extended to an angel investor.

No. 6: Retaining Equity

Another investor exit strategy is to not exit a startup. This type of move can be beneficial if a company achieves profitability but is not planning to sell nor release an IPO. In these instances, sticking with an investment may result in the angel investor receiving a regular dividend for their ownership stake.

Now that we've covered the most common exit strategies for angel investors, let's discuss when the right time is for you to exit your investment.

Knowing the Right Time to Exit

Because nine out of 10 angel investments go south, angel investors seek to make impressive returns from the 10% of their investments that do generate a profit.

As previously mentioned, in general, angel investors seek at least a 30% return on their angel investments.

A streetlight with a directional arrow reading, "Exit Strategy."

That said, keep in mind that it takes time to receive that return. Most startups take three to five years to reach a point where they can start pursuing an exit strategy. Meanwhile, the angel investor may be involved in the decision-making during this time as there are various scenarios that can come into play.

For instance, should another company offer to buy the startup, a decision must be made on whether or not to sell. Another instance could be the question of whether or not an IPO makes sense for the company and its investors. Additionally, there is the question of whether the startup can afford to start paying a dividend to its investors.

These are some of questions that startups and their angel investors must fully address as they approach a time when an exit strategy seems a likely possibility.

Ultimately, the truth is there's no one-size-fits-all answer to knowing when the time is right to exit your angel investments. The right decision is dependent upon many variables specific to each situation, including what best serves you, as the angel investor.

The key lesson here is to have a thoroughly mapped-out angel investor exit strategy in mind before investing in a startup.

Let's walk through developing an exit strategy.

How to Develop an Exit Strategy

When looking for startup companies to invest in, you'll want to ensure there is an investor exit strategy in place.

Your exit strategy depends on the company in which you'll be investing. This is why experts recommend that an angel investor is well-acquainted with and understands what the startup's founders have planned for their exit strategy.

Thus, it is key for the founders to include an exit strategy in their business plan.

Keep in mind that the details and specifics may shift over time. Additionally, note that rarely does a business grow as planned and a startup's exit strategy may also need to change or adapt to market changes. If so, know that's okay.

On the other hand, an item of concern for a prospective angel investor is if the company's leaders aren't thinking about an exit or do not have an exit strategy put in place. Again, an exit strategy is how you, as the angel investor, will get your money back, so it's recommended that you keep this top of mind.

When reviewing a startup's buyout strategy, there are some elements to look for - let's examine them below.

Questions to ask when reviewing a startup's buyout strategy graphic

First, note whether the founders have identified any companies that may have an interest in buying the startup. If so, inquire about the specifics, not just generalities.

For example, do the leaders say the business may be an acquisition target for "a large tech company", such as Salesforce? Or do they explicitly state something like, "We're building a customer relationship management tool that we think will be attractive to Salesforce"?

Furthermore, check to make sure the founders know why another company may be interested in acquiring their startup business. What is it about this startup that would make it appealing for another business? What needs or challenges are they addressing that could easily benefit another company should the startup be acquired? For example, is the startup developing or building a competing tool that could potentially benefit the other company by incorporating into its offerings?

Also, it would be helpful to know what the founders think the acquiring company might pay for the startup. You can use this number to help calculate your potential return on investment.

Lastly, make sure you understand the startup leaders' timeline.

Let's say they're not planning to seek an exit for six or seven years. If so, will you be comfortable waiting that long before seeing a return on your investment?

The Best Angel Investor Exit Strategy Is Having One

As mentioned earlier, angel investing is a risky business. There's no guarantee you'll get your money back or make a profit off of your investment.

Yet all it takes is one successful angel investment for you to earn an impressive return.

Having an angel investor exit strategy in place when you invest in a startup is key to making your final decision to invest. This way, you can be equipped for when the company you invest in is at a point where you can take your profit and go.

Want to learn more about becoming an angel investor? See our complete guide to angel investing. Learn how to become an angel investor, discover the various types of startup investors, and see examples of angel investors.

Think you're ready to become an angel investor? Check out the best startups to invest in.

Are you looking for a fantastic way to get started as an angel investor? Visit the Angels & Entrepreneurs Network for an affordable and easy way to start investing in startups!