Everyone loves talking about unicorn valuations and the next groundbreaking startup, but how often do we talk about cashing out? Because a deal isn’t truly a win until the money is back in the bank.
In the world of startup investing, there is one universal truth, entering is easy, exiting is hard. This is where venture capitalists truly earn their stripes.
Investors put in capital with the expectation of outsized returns, but those returns only materialize when there is a successful exit. The timing, method, and conditions of that exit often determine whether an investment was a good one or just another learning experience.
Early-Stage vs. Growth-Stage Investors
- Early-stage investors are the brave pioneers who fund a company when the product, market, and business model are still evolving. This group includes friends and family, angel investors, and early-stage venture capital (VC) firms. Their capital is a lifeline, and their returns are often tied to the company’s long-term success. For them, exits typically come in two forms: secondary sales and mergers and acquisitions (M&A).
- Growth-stage investors, on the other hand, enter the scene when a company has a proven business model and is ready to scale. These are larger VC funds, private equity firms, and strategic investors that inject significant capital once the business has product-market fit and is scaling, to fuel expansion. Their exit options are similar to the early-stage investors, with the addition of the highly coveted Initial Public Offering (IPO).
Each group has its own exit paths and considerations and understanding these can make all the difference in generating meaningful returns.
The Reality of Secondary Sales and M&A
For early backers, exits typically happen through secondary sales or M&A transactions.
- Secondary Sales: This is when early investors sell their shares to incoming investors during a later funding round. In bullish markets, secondary transactions may happen at 15-30% discount to the primary round valuation, a small price for liquidity. But in a distressed scenario, that discount can skyrocket to over 50%. For example, early investors in Paytm were able to partially exit before the IPO at healthy multiples. On the other hand, in a bearish market, discounts can exceed 50%, as seen in PharmEasy’s distressed secondary sales in 2023, where valuations were marked down sharply.
- Mergers and acquisitions (M&A): When a larger corporation acquires the startup, the valuation is usually based on strategic fit and intrinsic value rather than aggressive VC multiples. For early investors, this can sometimes mean just getting their initial capital back. For instance, when Flipkart acquired Myntra, early investors saw a respectable exit, but valuations were nowhere near the peak multiples. A truly profitable M&A for investors occurs only when the acquisition is seen as a massive value unlock for the acquiring entity, justifying a higher price – like Zomato acquiring Blinkit, which strengthened its quick-commerce play.
Exit Options for Growth-Stage Investors
Growth-stage investors usually look at M&A or IPO as their primary exit routes.
- M&A: Similar dynamics apply as in early-stage deals, but since growth investors typically come in at higher valuations, M&A exits must be at meaningful premiums for them to generate returns.
- The Allure of the IPO: Consider Mamaearth’s IPO, which allowed investors like Sofina and Fireside Ventures to book significant profits, turning years of patient capital into cash.
An IPO is often considered the most profitable and celebrated exit scenario. It’s a non-distressed liquidity event, where the company and its investors get to ‘ring the bell’ on a major stock exchange. For investors, this can translate into outsized return on their initial investment, often at a premium valuation. It’s the dream scenario, symbolizing a company’s maturity and market confidence.
However, not all exits are this glamorous. Many exits are a result of complex circumstances and can be characterized as “distressed” liquidity events.
Understanding Distressed Liquidity
Not all exits are planned or timed to perfection. There are several scenarios where investors are forced into distressed liquidity events. These distressed exits are not a sign of failure but rather a reality of the fast-paced startup world. They can occur for a variety of reasons, forcing investors to sell their shares at a discount. Here are a few common scenarios:
- New Investor Requirements: When new investors insist on buying a minimum secondary stake at a discount as a precondition to invest. For instance, several late-stage funding rounds in 2022–23 saw founders and early investors liquidate some stake at a discount to make room for fresh capital. This move, while seemingly painful, can be in the best interest of the company’s long-term growth.
- Business Model Pivot: Startups are dynamic, and sometimes a change in their core business model no longer aligns with an investor’s original mandate. A VC fund that invested in a B2B SaaS company might not want to hold shares in a company that pivots to a B2C e-commerce model, leading them to seek an exit at the next available opportunity — sometimes at steep discounts for instant liquidity.
- Material Adverse Changes: Unforeseen events, like a major market shift or a change in the founding team, can trigger what’s known as a “materially adverse change.” This can force investors to liquidate their position to mitigate risk, often at a significant discount.
- Fund Life Cycle Constraints: Many VC funds are bound by a 7–10 year life. As fund closure approaches, managers may be forced to liquidate, even if timing isn’t optimal.
Tracking entity-level exit timelines and negotiating from a position of strength — rather than desperation — is key to maximizing returns.
The Role of Patience and Mindful Investing
At Auxano, we have seen this play out first-hand. Over the last six months, we exited three portfolio companies, all of which delivered returns north of 30% IRR — none under distressed circumstances. This outcome is a testament to our patience, persistence, and close collaboration with founders, rather than rushing for quick exits.
We focus not on the number of deals closed but on the quality of outcomes. For us, “less is more.” We begin with the end in mind, aligning with founders early about potential exit strategies, so we are never cornered into a suboptimal outcome.
We don’t just support entrepreneurs; we also focus on maximising returns for our investors.
Founders & ESOP Holders – The Forgotten Stakeholders
While investor exits often make headlines, founders and ESOP holders (startup employees) are usually the last to see liquidity. As the ecosystem matures, it’s critical that they are not left out of wealth creation. After all, apart from passion and vision, monetary upside is the second-largest motivator for entrepreneurs and early employees. Facilitating liquidity for them creates stronger, more committed teams and healthier companies.
Closing Thoughts
Exits are where the rubber meets the road. They separate good investors from great ones and determine whether capital continues to flow into the startup ecosystem. Mindful investing and planned exits — rather than speculative bubbles — will shape the next decade of wealth creation.
Laser sharp focus on sustainable growth and fair exits will ensure that all stakeholders—from financial investors to founders and even ESOP holders—benefit from the wealth creation process. Because in the end, a company’s true value isn’t just in its potential, but in its ability to generate real returns for those who believed in it from the start.
It is imperative for the founders to think about exit scenarios early, not as an afterthought. This alignment between investors and founders avoids surprises later and ensures everyone is rowing in the same direction.
Author
Karan Gupta
