# Understanding Exit Strategies: How Investors and Businesses Can Plan Their Exit

![Exit Strategy: A contingency plan to liquidate an investment in a business venture or financial asset once predetermined criteria have been met or exceeded.](https://www.investopedia.com/thmb/KcLrYw-iHYoN-lGYcTrdbn2BHeE=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/exitstrategy.asp-final-a77bf1dc9e9c48f980c294b77ef1ef7e.png)

*— Investopedia / Julie Bang*

## What Is an Exit Strategy?

An exit strategy is a backup plan for an [investor](https://www.investopedia.com/terms/i/investor.asp), [venture capitalist](https://www.investopedia.com/terms/v/venturecapital.asp), or business owner to sell a financial asset or business assets once certain conditions are met. It may be executed to exit a nonperforming investment or close an unprofitable business. Here, the exit strategy aims to limit losses.  

An exit strategy may also be executed when an investment or business venture has met its profit objective. For instance, an [angel investor](https://www.investopedia.com/terms/a/angelinvestor.asp) in a startup company may plan an exit strategy through an [initial public offering (IPO)](https://www.investopedia.com/terms/i/ipo.asp). Reasons for an exit strategy can include market changes, legal issues like [estate planning](https://www.investopedia.com/terms/e/estateplanning.asp) or lawsuits, or retirement plans for the owner or investor. Planning an exit strategy ahead of time is an effective way to manage risks.

### Key Takeaways

*   An exit strategy is a crucial part of managing investments or business ventures, allowing investors and business owners to liquidate their assets under pre-set conditions to maximize profits or minimize losses.
*   For startups, common exit strategies include initial public offerings (IPOs), strategic acquisitions, and management buyouts, while established businesses often opt for mergers and acquisitions or, in unfavorable circumstances, liquidation or bankruptcy.
*   Investors use various exit strategies, such as the 1% rule, percentage-based exits, and time-based exits, to manage risk and maximize returns, ensuring an objective approach to decision-making without emotional bias.
*   Implementing a well-defined exit plan helps in succession planning, goal setting, and preparation for unexpected events, highlighting its importance in safeguarding business interests and assets.  
      
    

## How Exit Strategies Work

An effective exit strategy should be planned for every positive and negative [contingency](https://www.investopedia.com/terms/c/contingency.asp) regardless of the investment type or business venture. This planning should be integral to determining the risk associated with the investment or business venture.

An exit strategy outlines how a business owner will sell their company ownership to investors or another company. It outlines a process to reduce or liquidate ownership in a business and, if the business is successful, make a substantial profit.

If the business is not successful, an exit strategy (or exit plan) enables the owner to limit losses. An exit strategy may also be used by an investor, such as a venture capitalist, to prepare for a cash-out of an investment.

For investors, exit strategies and other money management techniques can greatly help remove emotion and reduce [risk](https://www.investopedia.com/terms/f/financialrisk.asp). Before entering an investment, investors should set a point at which they will sell for a loss and a point at which they will sell for a gain.

## Why You Need an Exit Strategy

Business owners, whether of small or large companies, need plans to manage their business exit. An entrepreneur of a startup may exit their business through an IPO, a strategic acquisition, or a management buyout, while the CEO of a larger company may turn to [mergers and acquisitions](https://www.investopedia.com/terms/m/mergersandacquisitions.asp) as an exit strategy.

Investors like venture capitalists or angel investors need an exit plan to reduce risk from poor investments and explore other opportunities. A well-thought-out exit strategy also provides guidance on when to book profits on unrealized gains.

## The Importance of Having an Exit Strategy

Businesses and investors should have a clearly defined exit plan to minimize potential losses and maximize profits on their investments. Here are several specific reasons why it’s important to have an exit plan.

**Removes emotions**: An exit plan removes [emotions](https://www.investopedia.com/articles/basics/10/how-to-avoid-emotional-investing.asp) from the decision-making process. Setting a clear exit point helps avoid panic selling and rushed decisions, preventing losses or missed profits.  
  
  
**Goal setting**: Having an exit plan with specific goals helps answer important questions and guides future strategic decision-making. For example, a startup’s exit plan might include a future buyout price that it would accept based on [revenue](https://www.investopedia.com/terms/r/revenue.asp) turnover. That figure would help make strategic decisions about how big to grow the company to reach predetermined sales targets.

**Unexpected events**: Unexpected events are a part of life. Therefore, it’s essential to have an exit strategy for what happens when things don’t go to plan. For instance, what happens to a business if the owner faces an unexpected illness? What happens if the company loses a key supplier or customer? These situations need planning in advance to minimize potential losses and capitalize on gains.

**Succession planning**: An exit plan specifies what happens to the business when key personnel leave. For example, an exit strategy might stipulate through a [succession plan](https://www.investopedia.com/terms/s/succession-planning.asp) that the company passes to another family member or that the business sells a stake to other owners or founders. Carefully detailed succession planning of an exit strategy can help avoid potential conflict when a business owner wants to or has to depart.

## Effective Exit Strategies for Startups

In the case of a [startup](https://www.investopedia.com/terms/s/startup.asp) business, successful entrepreneurs plan for a comprehensive exit strategy to prepare for business operations not meeting predetermined milestones.

If [cash flow](https://www.investopedia.com/terms/c/cashflow.asp) draws down to a point where business operations are no longer sustainable, and an external [capital](https://www.investopedia.com/terms/c/capital.asp) infusion is no longer feasible to maintain operations, then a planned termination of operations and a liquidation of all assets are sometimes the best options to limit further losses.

Most venture capitalists insist that a carefully planned exit strategy be included in a business plan before committing any capital. Business owners or investors may also choose to exit if a lucrative offer for the business is tendered by another party.

Ideally, an entrepreneur will develop an exit strategy in their initial business plan before launching the business. The choice of an exit plan will influence business development decisions. Common types of exit strategies include IPOs, strategic [acquisitions](https://www.investopedia.com/terms/a/acquisition.asp), and management buyouts (MBOs).

The exit strategy that an entrepreneur chooses depends on many factors, such as how much control or involvement they want to retain in the business, whether they want the company to continue being operated in the same way, or if they are willing to see it change going forward. The entrepreneur will want to be paid a fair price for their ownership share.

A strategic acquisition frees the founder from ownership duties but also means losing control. IPOs are often considered the ultimate exit strategy since they are associated with prestige and high payoffs. Contrastingly, [bankruptcy](https://www.investopedia.com/terms/b/bankruptcy.asp) is seen as the least desirable way to exit a startup.

A key aspect of an exit strategy is business [valuation](https://www.investopedia.com/terms/v/valuation.asp), and there are specialists who can help business owners (and buyers) examine a company’s [financial statements](https://www.investopedia.com/terms/f/financial-statements.asp) to determine a fair value. There are also transition managers whose role is to assist sellers with their business exit strategies.

## Proven Exit Options for Established Companies

In the case of an established business, successful [CEOs](https://www.investopedia.com/articles/financial-theory/10/manage-business-like-jack-welch.asp) develop a comprehensive exit strategy as part of their contingency planning for the company.

Larger businesses often favor a merger or acquisition as an exit strategy, as it can be a lucrative way to remunerate owners and/or shareholders. Rival companies often pay a premium to buy out a company that allows them to increase [market share](https://www.investopedia.com/terms/m/marketshare.asp), acquire intellectual property, or eliminate competition. This raises the prospects of other rivals also placing a bid for the company, ultimately rewarding the sellers of the business.

However, a merger-and-acquisition-focused exit strategy should factor in the time and costs to organize large deals as well as regulatory considerations, such as [antitrust laws](https://www.investopedia.com/terms/a/antitrust.asp).

Established companies also plan for how to exit a failing business, which usually involves liquidation or bankruptcy. Liquidation consists of closing down the business and selling off all its [assets](https://www.investopedia.com/terms/a/asset.asp), with any leftover cash going toward paying off [debts](https://www.investopedia.com/terms/d/debt.asp) and distributing among [shareholders](https://www.investopedia.com/terms/s/shareholder.asp). 

As mentioned above, most businesses see bankruptcy as a last-resort exit; however, it sometimes becomes the only viable option. Under this scenario, a company’s assets are seized, and it receives relief from its debts. However, declaring bankruptcy could prevent business owners from [borrowing credit](https://www.investopedia.com/articles/pf/07/after-bankruptcy.asp) or starting another company in the future.

## Smart Exit Strategies for Investors

Investors can use several different exit strategies to prudently manage their investments. Below, we look at several strategies that help minimize losses and maximize gains.

**Selling equity stake**: Investors with shares in a startup or small company could exit by selling their [equity](https://www.investopedia.com/terms/e/equity.asp) stake in the business to other investors or a family member. Selling an equity stake may form part of a succession plan agreed upon by founders when starting a business. If selling a startup stake to a family member, it’s important that they understand any conditions tied to the investment.

**The 1% rule**: Investors apply this rule by exiting an investment if the maximum loss equals 1% of their liquid [net worth](https://www.investopedia.com/terms/n/networth.asp). For example, if Olivia has a liquid net worth of $2 million, she would cut an investment if it generates a loss of $20,000 ((1 ÷ 100) × 2,000,000). The 1% rule helps investors take a systematic approach to protect their capital.

**Percentage exit**: Using this strategy, investors exit an investment when it has gained or fallen by a certain percentage from its purchase price. For instance, Ethan, an angel investor, may decide to sell his share in a startup if it achieves a 300% [return on investment (ROI)](https://www.investopedia.com/terms/r/returnoninvestment.asp). Conversely, Amelia, a venture capitalist, may decide to sell her share in a startup if it drops 20% in value.

**Time-based exit**: Investors apply this strategy by exiting their investment after a specific amount of time has passed. For example, Noah may decide to sell his stake in a business after 18 months if it has not generated a positive return. A time-based exit helps free up capital from underperforming investments that could be used for other opportunities.

## Why Is It Important to Have an Exit Plan?

Businesses should have a clearly defined exit plan to help manage risk and capitalize on opportunities. Specifically, an exit plan helps remove emotion from decision-making, assists with strategic direction, helps to plan for unexpected events, and provides details about an actionable succession plan. 

## What Are Common Exit Strategies Used by Startups?

Exit strategies used by early-stage companies include initial public offerings (IPOs), strategic acquisitions, and management buyouts (MBOs). Entrepreneurs typically select an exit plan before launching a business that fits their longer-term business development decisions and goals. The exit strategy that an entrepreneur chooses depends on factors such as how much involvement they want to retain in the business and its future long-term potential.

## What Are Common Exit Strategies Used by Established Companies?

More established companies favor mergers and acquisitions as an exit strategy because they often lead to a favorable deal for shareholders, particularly if a rival company wants to increase its market share or acquire intellectual property. Larger companies may exit a loss-making business by liquidating their assets or declaring bankruptcy.  

## What Exit Strategies Can Investors Use?

Investors can capitalize on gains and reduce risk by using exit strategies such as the 1% rule, a percentage-based exit, a time-based exit, or selling their equity stake in a business to other investors or family members. Investors typically set an exit strategy before entering into an investment, as it helps to manage emotions and determine if there is a favorable [risk-return tradeoff](https://www.investopedia.com/terms/r/riskreturntradeoff.asp).  

## The Bottom Line

An exit strategy is a plan to liquidate or dispose of an investment or asset when specific conditions are met. The dual purpose of exit strategies is to minimize losses and maximize profits by removing emotional decision-making and establishing clear financial goals. Investors can utilize exit plans, like the 1% rule, percentage- or time-based exits, or selling equity stakes to manage risk and ensure favorable outcomes.

It's important to have an exit strategy in place for various scenarios, ranging from startups to established businesses. For startups, common exit strategies include IPOs, strategic acquisitions, and management buyouts. For established businesses, there is a preference for mergers and acquisitions, but when faced with insolvency, liquidation or bankruptcy are unfortunate final options.  

> **Article Sources**
>
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>     
> 2.  AllBusiness.com, via Internet Archive Wayback Machine. “[10 Reasons Why Your Exit Strategy Is as Important as Your Business Plan](https://web.archive.org/web/20210219024515/https://www.allbusiness.com/business-exit-strategy-business-plan-119617-1.html).”
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> 3.  Ansarada. “[Different Business Exit Strategies, Their Pros and Cons](https://www.ansarada.com/business-exits/strategies).”
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