equity investor exit strategy

An equity investor is investing $1000 for a period of 5 years, equity share holding percentage 80% & my percentage 20%.

In a normal scenario, when does an investor exit?

1. The moment he gets his $1000 back.
2. He will keep on taking share in the profits till V yr as initially he agreed to invest money for 5 years.
3. He might say at the time of investing money he would expect a return of $2000. So he will keep on taking his share of profits until he gets $2000 and he will exit.

Please refer to the following example:

• An investor is investing a total of $1000. Investors equity share holding percentage 80% and my percentage 20%.
• Yearly net profit for I yr $400, so investor will get $320 and I will get $80.
• Yearly net profit for II yr $800, so investor will get $640, I will get $160.
• Yearly net profit for III yr $1000, investor will get $800, I will get $200.
• Yearly net profit for IV yr $1200, investor will get $960, I will get $240.
• Yearly net profit for V yr $1600, investor will get $1280, I will get $320.

My query is when will the investor exit:

1. Will investor exit in the beginning of III yr when he gets his $1000 back and then to benefit more use exit strategies like selling of his share, IPO etc.
2. If in the beginning we have agreed that he would invest for a period of 5 yrs, so he will still get the share in the profit till 5 yrs even he has received back his $1000 investment in the beginning of the III yr.
3. In the beginning the investor will put condition that he wants a specific amount in return (e.g. $2000). So he will exit in the mid of IV yr the moment he has received his $2000 and again to benefit more use exit strategies like selling his shares, IPO, etc.

No investor is going to cash out after he gets his initial investment back. That's not investing -- it's an interest-free loan.

So, the only logical way to interpret your question is that after 5 years, the investor transfers or sells his/her share of the company back to the company.

But, you have to look to the actual documents that define the investment. If all you have is a statement "I'm going to invest $1000 for 5 years," then it's completely ambiguous.

I think your assumption is that an investor is only a short term relationship like a bank loaning you money, which once you repay your out. That isn't the case.

Generally buying shares is no different to buying a car or a tshirt, you own it until you sell it again. The amount you make when you sell (higher or lower) is your return on your investment.

If your company is earning money and paying dividens, then this is similar to you using your car as a taxi, it earns you money along the way while you still own it. You can loan it to other people so they can make money along the way, but you still own the car and your selling the car is seperate to earning along the way.

If your company has made a profit in a given year or quarter then you may choose to share the profits between the owners. Similar to the taxi, after you have paid the driver, paid for the petrol, paid for the maintence on the car, the left over money is the profit and is the owners to do what they want with.

In your case, there are 2 owners and you are splitting the profit based on how much each one owns. 80% and 20% respectively. Typically in the early years they opt to reinvest all of it back into the business so they can do more in the next year.

Now your investing for 5 years statement is somewhat usual and the source of misunderstanding. Without anything else happening they will continue to own their part of the company at the end of year 5. So there are a few options:

• You may be asked to buy out the shares at the year 5 point for a agreed amount of money or based on the value of the business at the buyout point. Be careful of this one, if your required to pay 2x or 5x the investment amount regardless then your not in a good position, if the business isn't running perfectly your not going to be able to pay your debt.
• They may choose to sell the shares to other people at the 5 year point. This is worrying to you because you may not get a say in who your new co-owners are ... what if they want to take you car and enter it in off road races instead?
• They could be very nice and give you the shares back because they are fedup. This is not very likely to be planned for at the beginning.
• They IPO or trade sale (selling to another company) is an option you both need to agree on and would be the most likely successful exit, though 5 years is typically fair short if your starting the whole thing today.

I think its worth drawing up an agreement on paper detailing the "sunset clause" along with the other expectations both you and your investor have around the following:

• Who gets paid from the investment money along the way?
• Who is doing what part of the business operations?
• Who gets paid from the business operations?
• Who owns what? If you break the car apart, who owns the engine, the seats, the steering wheel ... for a business this is who owns the product, who owns the right to make the product again, who owns the brand name.
• If you do go your seperate ways can either of you start up again in the same space? can both of you?
• If more money is needed in year 3 or year 5, where is this going to come from? (bank loans, new investors, more from the current investor)
• If you are going to do a trade sale, who is most likely going to buy you and why would they want to buy you? This potentially changes the way you build your business and the things you choose to invest your time and money in.
• If your doing an IPO this is a big undertaking but it would be one point they could get their money back. Is this what you both want to target?

Then once you have discussed and written down all of these answers, take that to a lawyer to get advice and a legal version of it written up.

The investor owns 80% of the shares. His plan states that he's investing in your business for 5 years - however, until he sells his shares, he is still an investor, and once he sells his shares, he is not.

The 5 years is the time frame that the investor expects to recover his investment. If your business does really well, and he recovers his investment plus profit in 1 year, he may choose to sell his shares (perhaps to you, perhaps back to the business) early. If the business does poorly, he may choose to hold on to his shares longer than the 5 years.

As long as he owns his shares, he is entitled, subject to whatever agreement you have in place, to share in the profits. Assuming a single class of shares, then any time your business issues a dividend, he will collect 80% of the total amount paid, and you 20%.

Addendum The investor will not be likely to sell his shares early unless he can get a really good return on his initial investment. The 5 years is just a general estimate of by when he expects to see a decent return (e.g. 20% back in year 1, 40% in year 2, 80% in years 3 and 4, and 100% in year 5, for a running total of 320%).