Exits
How does a VC-backed acquisition work?
Quick Answer
In an acquisition exit, a larger company buys the startup. Proceeds flow through the liquidation waterfall: debt first, then preferred shareholders (VCs) get their liquidation preference, then remaining proceeds are distributed based on ownership percentages.
Detailed Answer
Acquisitions are the most common exit path for VC-backed startups. Understanding the mechanics is critical for both founders and investors.
Acquisition process: 1. **Interest/approach** — Buyer makes informal contact or formal offer 2. **LOI (Letter of Intent)** — Non-binding agreement on price and key terms 3. **Due diligence** — Buyer examines financials, legal, technology, HR (4-8 weeks) 4. **Definitive agreement** — Binding purchase agreement 5. **Closing** — Transfer of shares, payment of consideration
How proceeds are distributed (liquidation waterfall): 1. **Debt** — Any outstanding loans or convertible notes paid first 2. **Liquidation preferences** — Preferred shareholders (VCs) get their preference amount 3. **Remaining proceeds** — Distributed to all shareholders proportionally (or preferred converts to common)
Example: Company sells for $30M. Investors have $10M in liquidation preferences (1x). - Step 1: Investors take $10M preference - Step 2: Investors choose — keep $10M or convert to their % of $30M - If investors own 40%: 40% × $30M = $12M > $10M, so they convert - Founders (60%): $18M | Investors (40%): $12M
Types of acquisition consideration: - **Cash** — Clean, immediate liquidity - **Stock** — Buyer's shares (may have lock-up restrictions) - **Earnout** — Portion contingent on post-acquisition performance milestones
Founder alert: Always model the waterfall before negotiating. Small differences in terms (participating vs. non-participating preference) can mean millions in different outcomes.
Related Questions
What is an exit in venture capital?
An exit is how VC investors realize returns on their investment — typically through IPO (public offering), acquisition (M&A), or secondary sale. The exit is where returns are generated, usually 5-10 years after initial investment.
What is an IPO?
An IPO (Initial Public Offering) is when a private company first sells shares to the public on a stock exchange, raising capital and providing liquidity for early investors. It's the highest-return exit path for VCs, though only ~1% of VC-backed companies achieve it.
What is a secondary sale?
A secondary sale is when existing shareholders (founders, employees, or early investors) sell their shares to other investors before an IPO or acquisition. It provides partial liquidity without a full exit event.
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