Dividends are the New Exit

As an angel investor, your number one question when making an investment is, or should be, “how will I get my money back again?”

Conventional wisdom with high-growth entrepreneurial firms is that there are two primary ways to do this: either through an exit, i.e. sale of the company, or through an IPO, which is very rare today. So as an entrepreneur taking angel funds your mission becomes to build your company and then sell it. If you don’t sell, nobody can get their money back.

This overlooks a third, old-fashioned, way to return money to investors: dividends.

In the old days, people didn’t invest in businesses for the capital gains: they did it for the dividends. If a company was growing and profitable, it would return some of those profits each year as dividends to the shareholders. Think about it as an investor for a moment: would you rather own a stock that pays dividends each year, or a stock that might be sold to a new owner after five to 10 years for a whole bunch of money? Which is a more reassuring situation to be in?

In a small company, dividends can be an exceptionally good way to reward management. Management often owns large amounts of the shares. Rather than paying management a bonus for a job well done, why not limit management’s salary and cash bonus? If management wants a bonus for generating huge profits, they can get it along with all other shareholders: through a dividend.

I’ve made 10 angel investments. The most successful of those investments, which is profitable and growing nicely, paid out a dividend over a year ago: they issued a dividend equal to the initial angel investment, spread among all shareholders. It gives a nice feeling, as an angel, to receive that money, while knowing that the company still has lots of cash. (In this case they are grooming themselves for a sale as well: whether that happens or not, I still feel good having cash in my pocket now.)

As an entrepreneur, when I have been pitching and been asked about our exit strategy, I have tried a couple of times to mention dividends as a possible option. Professional angel group investors look at me strangely, and discount me and the answer: it’s clear that’s “the wrong answer.” Many individual angels seem quite happy with the answer though—in their position I know I would be.

It may not yet be acceptable in some circles to say that dividends are the third exit scenario. It doesn’t change the fact that it is still a great strategy, which rewards both management and angel investors for creating a profitable company.

As an entrepreneur, I strongly encourage you to think about paying dividends as soon as you safely can. You’ll have happy investors. You’ll get cash out of the company, whether you sell the company or not. And your pressure to take the first offer you get will be substantially reduced, so you can wait for the right offer.