Part 3 of 7
We have been looking at the two-fold challenge faced by Business Owners wishing to “extract themselves and their wealth” from their businesses in the next decade. Firstly, that the economic recovery may be slow, and, secondly, that the retirement of the Baby Boomers will put “10 million” businesses on the market in this period.
From this perspective, we recognize that many companies will not sell without careful planning and preparation. The point of considering possible “Positioning Strategies” is that most business are not being run with a mind to “selling”, and are typically not optimally prepared for an exit because:
- the ownership and management roles are not properly separated, and
- the key determinants of value, namely growth and risk, are not calibrated to the expectations and desires of market buyers (investors)
Exiting through a sale, recapitalization or merger generally involves investors and may involve lenders. Management is pivotal. Exiting through a transfer of the business to family, management or employees, or through a gifting strategy, may or may not involve lenders but, once again, management is a pivotal issue. Exiting through liquidation, on the other hand, does not depend on management to the same extent.
Generally, the different Exit Strategies depend on key considerations as follows:
| . | INVESTORS | LENDERS | MANAGEMENT |
| Sale | X | X | X |
| Recapitalization | X | X | X |
| Merger | X | X | X |
| Transfer | . | X | X |
| Gifting | . | . | X |
| Liquidation | X | . | . |
Let’s focus on the “sale / re-cap / merger” group of options which account for the majority of exits.
The first order of business is having a strong management
The Business Owner who runs his own business may expect that a buyer will operate the same way. While this is a possibility, it is more likely that the buyer will be a larger enterprise with a separate management or an investment group with no interest in participating in the operating management. With the possible exception of a competitor looking to add accounts, buyers will likely want to see themselves as “investors”, separate from the management.
In fact, if we take a look at the three key drivers of a successful sale at an optimal valuation, management is the key ingredient in all three.
- A business which is growing or has growth opportunity
- A business which is not unnecessarily exposed to known risks
- A business which is visible and open to a buyer and which presents very few unknowns or risks, i.e. a business which is marketable
The Objective is to optimize the value of the Wealth Transfer by attracting multiple competitive bids from Quality Buyers
Notice that we are talking about the value of the Wealth Transfer, not the “sale price” or even the “business valuation”. What is exchanged (cash, stock, notes, earn-out), under what conditions of risk or uncertainty, and when it is received …. all play into the “value” which the seller seeks.
Value (to the seller) is driven by Price, Terms (timing) and Structure
Multi-Step Exits
If the risk of leaving some wealth in the business is acceptable to the Business Owner, he may take some cash now and the rest later when the valuation is higher.
A classic two-stage exit is accomplished by means of a “re-capitalization” in which an investor / partner / buyer acquires part of the business with an expectation to either buy the rest of the business or to market the business in cooperation with the remaining owner at a later time and at a greater valuation. The owner “takes some chips off the table”, but retains a stake, and usually continues to participate in management.
Other “multi-step” exit strategies include:
- Selling an option to a qualified buyer
- Merging into another entity and liquidating that position later
- Growing the business through acquisitions, including consolidation or roll-up strategies
Valuation is driven by Growth and Certainty
Corporate Value Enhancement
The seller should look at the corporate structure and governance mechanisms to consider whether the business is optimally positioned, from both a legal and a tax standpoint, for the intended exit.
The make-up of the Board and any Advisory Board may have an impact on the value perceived by a buyer. The “vision” of Boards and Advisors can open up growth opportunities.
From the standpoints of the critical mass of the business, product or market diversity, management strength or any number of others, the business may benefit from a combination with or consolidation into another business prior to its sale. Alternatively, it may be desirable to spin-off one or more non-synergistic or non-performing divisions to increase profitability or allow greater management focus.
Business Value Enhancement
It doesn’t seem entirely logical that an exiting business owner would have unexplored opportunities available for increasing the value of the business, but the stakes are higher at the time of exit, and the focus on marketability and valuation greater, so that these opportunities become more visible.
With a mind to “setting the business on a higher level of sustainable growth” and/or “reducing the inherent risk (uncertainty) in the business”, the seller should consider:
- Reviewing & Revising the Revenue and/or Business Models
- Implementing Product / Market Enhancement Plans
- Expanding & Diversifying the Customer Base
- Securing title to Patents & Intellectual Property
- Commissioning Financial & Operational Audits
- Strengthening or upgrading Systems & Procedures
- Documenting or codifying Contractual Relationships (employees, vendors, customers, debt)
It’s what you keep … after tax
Tax Optimization
Sellers need to ensure that they have professional advice regarding the tax impact of an exit strategy. Certain strategies may involve significant advance planning.
Generally, tax strategies address opportunities for positioning transactions as “capital gains” vs. “ordinary income” or for deferring taxes, thereby increasing the time-adjusted value of the wealth extracted from the underlying assets.
In certain instances, such as when a business is held in a “C” Corporation, the seller faces a risk that the sale of the business assets may create a tax obligation to the corporation, followed by a further tax obligation to the owner when the proceeds are distributed out of the corporation. The result may be a “double taxation” on the proceeds of sale.
What you see is what you get
Business Marketability Enhancement
If growth opportunity, managed risk and strong margins are the foundation for building value enhancement strategies, then “clarity, transparency and certainty” are the engines which drive marketability. Business performance is clearly reported and accounted for, activities and status are transparent to the buyer, and all information portrays a level of certainty about the future.
Experienced buyers know that completing acquisitions is a time-consuming and expensive exercise. Buyers will perceive greater clarity, transparency and certainty, and therefore be more motivated to engage, when the seller has:
- Audited Financial Statements
- A Business Plan with a clearly defined growth path
- An in-place sector-experienced Management
- Current Market metrics and Analysis
Next: Part 4 of 7: Selling the Business
posted by Peter Heydenrych