Question & Answer
What Deal Structures Give Me the Most Control Over My Exit?
Control over your exit is one of the most critical aspects of any investment or acquisition. Whether you are a founder or an investor, the ability to dictate how and when you cash out can dramatically impact your returns. A well-structured deal ensures that you don’t get stuck in a situation where your exit is dictated by others or where your payout is at risk.
Key Deal Structures That Maximize Exit Control
There are several ways to structure a deal to ensure you have priority in determining when and how you exit. The most effective approaches involve securing rights, contractual clauses, and strategic share structuring.
Liquidation Preferences: Getting Paid First
A liquidation preference ensures that you, as an investor, get your money back before other shareholders receive their payouts. This is particularly useful in venture deals where the company may exit at a lower-than-expected valuation.
Example: If you invest $2M with a 2x liquidation preference, you are guaranteed $4M before common shareholders see any returns in an exit event.
Put Options: Forcing a Buyout
A put option gives you the right to sell your shares back to the company or another shareholder at a predetermined price after a certain period.
Example: After five years, you can trigger a put option requiring the company to buy your stake at a set valuation, ensuring liquidity.
Drag-Along Rights: Controlling the Sale Process
If you hold a significant position, a drag-along clause ensures that minority shareholders must sell their shares under the same terms if you choose to exit.
Example: You secure a buyer for your 40% stake, but the buyer wants 100% control. With drag-along rights, you can compel other shareholders to sell, ensuring the deal closes.
Tag-Along Rights: Selling on Equal Terms
Tag-along rights allow you to participate in a sale when a majority shareholder exits, ensuring you get the same terms.
Example: If the founder sells their stake at a premium valuation, tag-along rights ensure you can sell your shares at the same price.
Buy-Sell Agreements: Defining Exit Scenarios
A buy-sell agreement lays out pre-negotiated exit terms, ensuring that when a triggering event occurs (such as an acquisition or IPO), you have a guaranteed way to liquidate your stake.
Example: In a private company, a buy-sell clause states that if another shareholder exits, you have the first right to sell your shares at the same valuation.
Convertible Debt: Exit Before Equity Holders
Convertible notes allow you to start as a lender and later convert into equity, but if things go wrong, you can exit as a creditor rather than an equity holder.
Example: If the company underperforms, your convertible debt ensures you get paid back before shareholders, minimizing risk.
Call Options: Securing a Future Exit
A call option gives you the right to purchase shares at a set price before an exit, allowing you to increase your stake before a liquidity event.
Example: You hold a call option to buy an additional 10% at a predetermined price just before an acquisition, ensuring you capture more of the upside.
Example: Using Multiple Clauses to Control Exit
Imagine an investor who holds 25% equity in a startup. To protect their exit, they structure the deal with the following provisions:
- A 2x liquidation preference to ensure they get paid first in an acquisition.
- A put option after five years, allowing them to force a buyout.
- Tag-along rights to participate in any future share sale.
- A convertible debt structure to protect against downside risk.
By combining multiple protective clauses, the investor ensures that they can dictate when and how they exit, rather than being at the mercy of other shareholders.
Not all exits are equal, and without the right deal structure, you may find yourself trapped in an illiquid position. By leveraging liquidation preferences, put options, drag-along rights, and convertible debt structures, you can ensure a controlled and profitable exit.
Deal Structuring
Buy the book today and dive into practical techniques that empower you to get started immediately, navigating transactions efficiently and maximizing your success in minimizing cash requirements.
In this book, you will:
- Be introduced to the fundamentals of deal structuring
- Learn 19 proven deal models for structuring deals
- Discover 39 key elements of deal nuances
- Access 32 actionable clauses for your term sheets
- Explore 9 specific deal structures
- Receive 257 pages of invaluable insights
- Gain the distilled expertise of 20 years