Structured Exits: A New Path To Angel Liquidity?

Let’s face it: one of the biggest issues for many angels face is building liquidity into their portfolios.  Any time new ideas and alternatives come to build returns they are worth a good look.

David Gitlin, who co-leads the Emerging Technology Practice at Greenberg Traurig LP is a passionate voice for one alternative, “structured exits,” which are investment structures designed to achieve a desired investment return without reliance on a traditional exit. The Philadelphia-based attorney told me, “It’s very hard for companies and investors to get into a new mode of thinking, but the concept of structured exits is really a win-win for so many. Hopefully they will be more of the norm in the future. If I was running an investment group, I would seriously look at this.”

The main difference with a structured exit is that it allows you to structure your deal risk. You don’t gamble on whether or not there will be an exit and instead, you can start getting back your investment fairly quickly. While there are several types of structured exits, the key take-away is that this approach offers more options and significant benefits for angels.

Benefits of Structured Exits

  • Quicker liquidity—instead of waiting years for a big pay out, you receive smaller regular payouts, with the size and rate dependent on how you structure your deal.
  • Less risk—a predetermined payout is specified over a certain period of time.
  • Flexibility—deals can be structured in many different ways, for example a fixed or variable percentage; a cap of 3-5x investment or no cap; etc.
  • In case of an exit – equity “kickers” can be worked into the deal to account for an exit.
  • For the entrepreneur – little of no dilution in exchange for growth capital.

The flexibility of structured exits are very attractive and they can be adapted to fit the needs of angels and entrepreneurs.

The three main types of structured exits are demand dividends, equity/mandatory redemption, and cash-based loans.

Demand dividends and equity/mandatory redemptions are similar because they can be set up like royalty payments and are typically paid monthly soon after cash is received. It typically takes just a few years to regain your original investment. In an equity/mandatory redemption, your total payout is capped, so payments to you are done after you receive a certain amount past your investment. Demand dividend deals can be structured to include no cap on the investor’s return.  Both are taxed favorably to the investor.

With a cash-based loan the investor receives regular payments plus interest, tied in whole or in part to the company’s net available cash flow. If the company ends up liquidating, then the debt is the first thing that must be repaid. For tax purposes the interest earned on the loan is considered ordinary income, not part of capital gains tax, which may be less interesting for many investors.

Determining which of the three structured exits to use comes down to personal preference. The number one thing to consider is whether this type of deal is feasible for the company you want to work with. If there has been cash flow already, or if there is going to be cash flow soon, then a structured exit might be a good option.

Candidate Companies for Structured Exits

Structured exits work best with companies that don’t fit the traditional VC or angel equity deal. However Gitlin maintains they could work for many current venture-backed companies as well once investors think through this alternative way of financing startups. For now, most agree that companies with a limited or long pathway to exit are a good fit for structured exits. These might include:

  • Impact companies—those with a double mission of being self-sustaining and offering something for the greater good but may not show the high growth of other types of companies.
  • Revenue generating companies, such as restaurants or consumer novelties—potential upside for good growth, but limited opportunities for an exit as per the nature of the business.
  • Family-owned or multi-generational business—potential for growth oftentimes complicated by owners not wanting to exit.
  • Outside U.S./ Underserved geographies—not a lot of buyers for these companies even if they did want to exit as they have smaller markets and fewer ways to exit.

Structured exits offer some interesting options and may open the door to investment opportunities that we might not have otherwise considered. As angels, we need to be on the forefront of learning all we can about structured exits and educating other angels as well as entrepreneurs and their company board members. Gitlin’s detailed article on structured exits is a great primer. It discusses how each of the three types of structured exits work.

This blog originally appeared on Forbes. Marianne Hudson is an angel investor and the Executive Director of the Angel Capital Association (ACA), the world’s leading professional association for angel investors.