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27 Oct Using Reverse Mergers as an Exit Strategy for Investors

In the capital financing markets when founders are out pitching various investors they all-too-frequently fail to look at it from the perspective of the investor. Like betting on horses at the track, most investors can see a winner very early on in the business lifecycle. Either the business model and its operators get traction early-on or the business doesn’t acquire the mass-appeal needed for splendid hockey-stick growth. Don’t get me wrong, there are a lot of good companies that are the by product of tech incubators, angel investors and venture capitalists, but the number of smashing and great companies are much fewer. That doesn’t, however, mean that such “good” companies shouldn’t have an exit strategy for investors. In fact, it means the opposite–the investors will eventually demand it.

If a founding entrepreneur wanted to take the seat of the investor they would likely include a quick IRR/ROI and a fast business exit at the top of the list. From the investors’ perspective, they want to put their capital to work, get liquidity above the market, get out and do it again. Tying up capital in illiquid investments has a great deal of risk. Without an exit strategy, investors can often be stuck with equity (whether worthless or not equity does not equal liquidity and ROI), inventory, debt, litigation or other obligations. Investors like a see a plan for liquid exits from their investment. While not suitable for every single venture or angel-backed investment, they can certainly play a role in the exit strategy for getting a viable return on invested capital.

When presented with a viable exit strategy, including a timeline, investors are often much more likely to invest. Once the investment is made, the company is operations and the business is up and profitable, there a number of ways a reverse merger could be used to play a role in investor exits. The business could use a reverse merger to grow the company by acquisition. If investors see the vision, they could remain along for the ride. If they don’t, they can pull out their positions at any time.

Self-funded businesses can also benefit by using a “go public” strategy for gaining liquidity. Let me paint a picture as an example. Let’s say a long-standing business owner has a profitable business that has provided a good living for he and his family and perhaps some other close allies or friends. The shareholders don’t necessarily need to sell their equity, but some of the owners are getting old and would like to transition the business over to the next generation, but unfortunately the next generation lacks the funding to provide all the liquidity the owners would like in from a transaction. The owners have always thought about taking the business public for acquisitions sake, but have never considered doing so as a means of exiting their own investment. Without a very large investment in accounting, public securities and market making, the owners can have get their shares publicly traded and slowly cash out their position in the business.

It is important to understand, rarely are the strategies discussed here performed over night. It may take several years from start to finish, especially if an owner/insider wants to use public market liquidity to relinquish shares in the business. Doing so without causing damage to the business is also important, but the increased liquidity and exposure that comes from being public can be a boon for shareholders, including  venture and angel investors alike. There is always a time and a place for taking private companies public. If you’re investors are screaming for the exits, it may not be a good thing, as doing so with a gun to your head is never a good strategy, but if–as part of your pre-planned strategy to give investors a return–you plan on taking your company public. When you start your business, do so with a plan that includes an exit strategy for investors. Whether that includes a reverse merger or not, doesn’t matter so much, but plan on an exit and be as definitive about is as possible.

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Nate Nead
Nate Nead is a licensed investment banker and Principal at Deal Capital Partners, LLC which includes InvestmentBank.com and Crowdfund.co. Nate works works with middle-market corporate clients looking to acquire, sell, divest or raise growth capital from qualified buyers and institutional investors. He is the chief evangelist of the company's growing digital investment banking platform. Reliance Worldwide Investments, LLC a member of FINRA and SIPC and registered with the SEC and MSRB. Nate resides in Seattle, Washington.