The IBM Institute for Business Value and Oxford Economics conducted a study called ‘Entrepreneurial India’ which found out that 90% of Indian start-ups will fail in the first five years of their establishment.
The study included interviews of 600 start-up entrepreneurs of which 300 were Indian; 100 government leaders along with 100 venture capitalists, 1500 leaders of established companies, and 22 educational institutions.
The scope of this article is not to discuss the ‘why’ of the failures but about one of the exit strategies that can be classified as the last resort exit route though not necessarily so always; liquidation.
Liquidation is an exit strategy where you close the business and sell all of your assets - typically at a lower cost than the market price or book value.
What is an Exit Strategy in business?
Before we get into the topic of liquidation, let us explore various exit strategies available to start-ups. An exit strategy is a plan to exit a situation in the event of certain circumstances at a certain point in time. In business, exit strategy is about exiting the business or investment. The difference between these two is that in the first case it is the strategy to close or sell the company and the second case of exiting investment is of diluting the investment of the owners keeping the business alive. Many of the start-ups have an exit strategy as part of their business plan at the conceptual stage itself.
However, there arise situations where exit becomes inevitable though not planned for or at a point in time that was not foreseen to happen. This cannot be strictly called an exit strategy since there is no strategy or plan involved here. It is a decision forced to be taken out of the prevailing circumstances. Such situations normally emerge due to failure thanks to poor management, lack of expertise, negative cash flow, investor disinterest, bad or untested ideas, non-delegation of responsibilities, market conditions, recession, pandemic, adverse tax laws etc. It can also be because the owner believes that she or he has reached the expected and required target or made the required money out of the venture or the product life cycle has reached the end.
What are the common types of exit strategies?
We have heard of different routes to exit and let us briefly discuss a few of the most common of them here.
Merger & Acquisition (M&A): This very common route means merging of your business with another entity or being bought or acquired by another company. This is normally merging with a similar company, or being bought by a larger company, mostly larger company in similar or related business. This is an exit strategy to liquidate the investments of the struggling company and for the company on the other side it may be a growth driver. Such companies acquire other businesses for inorganic growth or economies of scale or cost efficiency or skill set of employees or strategic synergy because setting up a similar business from scratch takes lots of effort and time.
Initial Public Offering (IPO): IPO is about going to the public with an offer of sale of its shares and consequently getting listed on stock exchanges. This may not be an easy option for small and early start-ups as this involves complying with many regulations of SEBI, Companies Act, income Tax, RBI in certain cases etc. which specify stringent rules and regulations for companies going with IPO. In addition, it is not easy for the IPO to get subscribed by the public without good review, visibility and financial metrics in its favour. As far as the start-ups are concerned, this is usually a strategy enforced by non-promoter investors to exit their investment and take advantage of the premium valuation that might come through IPO which is exactly why they invest in the first place. This is not a common feasible route for struggling companies. This works for companies on the growth path looking for funds.
Dilution of equity: This is a common option most start-ups resort to. This is about diluting the promoter investment in the form of equity or capital by allotting shares to new investors against the fund they bring in, based on the valuation of the business as of then. This is not to be confused with an IPO. This may not be mostly a full exit as normally promoters remain in the company with majority or minority shareholding.
Sell to friends or relatives: This is not an M&A or liquidation route. The company does not close down or merge with another company. Yet it’s a great way to “cash out” so you can pay investors, pay yourself, take some time off, or venture into another business. The ideal buyer is someone you know well who has more skills and interest on the operational side of the business, and is confident of scaling it.
Close and Liquidate: This is our topic of discussion in this article. There are many reasons why business owners or investors decide to close down and liquidate their business. One reason can be the decision of the owner that enough is enough. Another can be the plan to exit the current business and try out something else or different. Mostly it is the companies struggling to survive which opt for this route in the form of voluntary liquidation. Other reasons may be that the idea was not tested properly before venturing into it resulting in failure or legal heirs or successors don’t want to continue the business. It can also be forced liquidation initiated by creditors who have not been paid their dues for long, to recover their money.
In business, exit strategy is about exiting the business or investment. The difference between these two is that in the first case it is the strategy to close or sell the company and the second case of exiting investment is of diluting the investment of the owners keeping the business alive.
So, what is Liquidation?
Liquidation is an exit strategy where you close the business and sell all of your assets – typically at a lower cost than the market price or book value. Do not see this as a bad option, this is a recommended strategy when the time has come to simply move on and/or you have run out of all other options to sustain. If you choose this route, just know that the process is to sell off the assets, use the cash obtained thus to pay off creditors and distribute whatever, if any, remains to the investors and shareholders including the founder owner, based on the contract in palace or share of stake as per the relevant laws.
As discussed elsewhere in this article, one of main reasons why start-ups fail is because the founders did not go through the much-needed procedure of testing the idea before venturing into implementing it. In such eventuality, if you have any protected IP, you must try to monetise it if some other entrepreneur has a better plan, skills and management resources to use your failed idea or IP and run it successfully. You can also consider the royalty route.
Coming back to liquidation, this route is normally selected when all other options like M&A, IPO, Sell-out don’t work out to the benefit of the business owner or become very complex and cumbersome for the owner to manage those routes without bringing in more resources and funds.
It may look like that the more beneficial way to exit a struggling or failed business is to sell it to potential buyers. This is, however, easier said than done especially if it is a struggling business. Hence the feasible and plausible option that will be available to a business owner who wants to exit the struggling business is to close and liquidate the business.
What are the liquidation processes?
This part is discussed here with reference to liquidation processes relevant to India under its applicable statues.
Insolvency and Bankruptcy code, 2016 is a consolidated enactment of various codes like Companies Act, 2013, Sick Industrial Companies (Special Provisions) Repeal Act, 2013, Limited Liability Partnership Act, 2008, Secularization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, Recovery of Debts Due to Banks and Financial Institutions Act, 1993. IBC, as it is commonly known, applies to the following entities.
Any company incorporated under the Companies Act, 2013 or any other previous law.
Any other company which is governed by any Special Act like government companies, government corporations
Limited Liability Partnership incorporated under the Limited Liability Partnership Act, 2008
Partnership firm whether registered or not under the Partnership Act, 1932
Any Individual Person
In a bid to ease recovery of dues from start-ups and enable faster exit, the Central Government in 2017 notified the provisions of the ‘Fast Track Insolvency Resolution Process’ under the Insolvency and Bankruptcy Code, 2016 labelled the Insolvency and Bankruptcy Board of India (Fast Track Insolvency Resolution Process for Corporate Persons) Regulations, 2017. This has come as a solace to start-ups which have been struggling all along and therefore want to exit in a smooth and fast mode.
The Regulations and the Fast-Track Resolution process are applicable to the following categories of corporate debtors meaning entities that want to liquidate the business:
a small company as defined under the Companies Act, 2013;
a Start-up (other than the partnership firm) as defined above; or
an unlisted company with total assets, as reported in the financial statement of the immediately preceding financial year, not exceeding rupees one crore.
The fast-track resolution is meant to expedite the insolvency resolution process of start-ups and small companies by cutting down the time taken to complete an insolvency resolution in a faster mode. The Fast-Track code stipulates that the fast-track process is required to be completed within a period of ninety (90) days, as against one-eighty (180) days in other cases, though can be extended by another 45 days for once under certain circumstances and conditions.
The fast-track process can be initiated by the creditors meaning those to whom business owes dues to pay or by the corporate debtor itself by filing an application to the IBC Adjudicating Authority.
The Regulations as a whole provide for the resolution process from the initiation of the insolvency resolution of the corporate debtors till its conclusion with approval of the resolution plan by the adjudicating authority within the set timelines thereby ensuring a speedy disposal of any application under the fast-track process.
Is Liquidation a rewarding experience?
The answer depends on various factors like whether this route was selected without trying out other exit strategies or it is a voluntary liquidation or one initiated by creditors. Other than in cases where the owners want to call it a day because they or their successors don’t want to pursue this business, owners take to the liquidation route as a last resort after undergoing a long period of struggle and trauma to keep the business alive and running. They are most probably in a mental state to exit the business as fast and smooth as possible. Going through another series of pain in the liquidation process may be something that they want to avoid at that point in time.
The prevailing statutes and codes under IBC ensure that this is avoided as far as possible. It also makes sure that all the stakeholders like creditors, employees, shareholders and investors have a win-win situation.
The liquidation strategy under current Indian laws provides companies particularly start-ups the best way to exit. This helps them by way of not wasting lots of time and effort so that they can pursue other endeavours. This also may provide them some money by way of funds remaining after settling the creditors.
In certain circumstances, that is the best option or only option available to the business owner, especially of failed or struggling start-ups.