HOW DO BUSINESS OWNERS CHOOSE THE RIGHT TYPE OF EXIT?
We are often bombarded with questions from potential sellers as to what is the right type of exit event for them?
Let me try and respond to some of the common questions which we have been asked and what we have experienced over the past 10 yrs of supporting entrepreneurs on their exit journeys.
What type of exit depends on many elements, but it’s all down to the owner’s short- and long-term aspirations.
Typically, they are only three exits;
1. If they (the seller) wants a partial exit, then it’s best to derisk your position with a minority share sale to private equity. This allows you to continue to run your business and also then generate cash for your personal life ( e.g. to pay the mortgage off, help fund the kids university fees/ housing ladder and have money for a rainy day/ buy a holiday home)
2. If someone literally wants out fully, then a trade sale is a highly attractive option (following any potential handover and / or earn out period). This way the seller/s exiting are fully free from the day to day running of the business and can pursue other activities which might be a new business venture, retirement, etc
3. The final type is typically a management buyout whereby the principal shareholders allow their management teams to buy up their shares and take over the running of the business. Owners can exit fully or partially by moving to a non-exec position as this allows them to maintain some input and guidance keeping an eye on things to mitigate any risk around receiving the deferred consideration for their equity.
Why would business owners opt for a trade sale, and what does this process entail?
Trade sales typically are the preferred option if owners/ shareholders wish to generate a cash consideration for their shares. There are tax implications such as capital gains which need to be considered. But having a good tax advisor onboard for the transaction should minimise that exposure. The process can entail trying to sell the company off market, whereby the owners approach known contacts within their industry (typically a competitor or partner) to ascertain their interest and then run a process from there. This is fraught with risk due too, typically, the inexperience of selling a business and the emotional connection sellers often have to their business. Quite often this will not maximise the exit valuation and the process will take longer. It is also distracting for the sellers and their core business will typically suffer given the focus of the exit.
The more favourable way is to appoint an advisor who is experienced in packaging and selling companies. They typically have a black book of buyers and can be more selective at running the process and can also remove the emotional state of mind, therefore managing the process more efficiently and maximising the value whilst allowing the seller to focus on running their business.
Why would business owners opt for a private equity sale, and what does this process entail?
Private equity buyers tend to have deep pockets and if they see the opportunity of synergy with other companies within their portfolio then they will/ could pay a premium. You would almost certainly appoint an advisor to manage the discussions and the process as you would be dealing with professional investors so structuring the deal as a “win-win” and managing the due diligence and legal process is vital.
Why would business owners opt for an IPO, and what does this process entail?
An Initial Public Offering (IPO) is a liquidity event which creates cash for shareholders to exit or reinvest into the company. The process of listing for an IPO is long and very expensive and will need to be managed by an advisory team of lawyers, tax advisors, bankers and a good solid PR company to drive the narrative. Once listed the costs of maintaining that listing is expensive due to the regulatory requirements.
Why would business owners opt for an employee ownership trust, and what does the process entail?
Employee options trust is a tax effective planning mechanism for a partial or full management buy out. Again you would need a team of advisors such as your account, tax advisors and lawyers who can draft the appropriate documentation and obtain HMRC clearance.
How can business owners make their company more attractive to buyers?
There are a whole range of metrics that buyers look at and if a seller knows that they are going to exit, plan well in advance (12-24 months) and track the following KPIs (not exhaustive);
- That monthly recurring revenue is +70% of total revenue (measure new MRR); Expansion MRR (additional MMR from Existing customers) Contraction MRR ( decline MMR from Existing Customers).
- Show growth and recurring customers and how they ramp up
Illustrate Customer churn ( ideally not more than 10% p,a) - Average aged debtor/ creditor days trending (ideally <45 days)
- Ensure no one customer is +10% of the entire company revenue stream
- Ensure EBITDA is growing YOY and its is a min of 15%
- Strong management teams with solid internal processes, governance and controls
- Sticky contracted customers which have strong terms and conditions
What is due diligence like for business exits? For instance, it might involve forensically investigating the company’s accounts, structures, tech, competition, etc.
Any Due Diligence (DD) process can be time consuming and very detail oriented. Expect a detailed review of current, future and historical trends in your data across finance, customer services, HR, sales/ marketing, legal (IP/ licensing) governance and controls. A scan of the competitive landscape is also likely.
Interviews with senior/ middle management and referencing with key customers, suppliers and partners will be included. It is vital to have an advisor manage this process as it’s very distracting for the seller and the buyer wants to perform detailed DD as swiftly, accurately and cost effectively as possible so setting up a formal data room (not sharepoint or Dropbox) is key.
If you sell your business, what will the deal look like?
Exits all depend on what the seller is looking for/ prepared to accept and what the seller is prepared to close out at. Deals range from 100% cash out on day 1 (rare) to share swaps and or anything in between. It is vital that any buyer and seller be honest from the initial discussion as to what they are trying to achieve and by when so both can understand/ agree.
What other processes should business owners be aware of?
Whilst buying and selling a company is common and there is a proven path to follow, I am always conscious of a buyer looking to chip the seller at the last minute on the price- if the seller smells blood (death, debt or divorce) then they may look to drive the price down at the last minute. Also be prepared to be chipped if anything is uncovered during the DD process that the buyer feels will / could create additional risk in the deal.
Internal and external communications are vital for the sanity of employees, partners, customers to ensure they understand what the transaction means to them. You don’t want them spooked.
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After reaching a deal, what should business owners do with their new money? Any wealth management advice would be great.
Have a champagne moment- celebrate with family/ friends and colleagues (and any advisory team). You have gone through years of sacrifice to grow your business and then months and months of legals, DD and negotiations so take the time to celebrate the success. If you have engaged an advisor in the sale process, you will know what you will do with your windfall. My advice would be to reduce/ repay any debts, get into a position of strength and then sit on the cash until you will think about what next in your life.
I trust you have enjoyed this short read. If you would like to hold an initial discussion then please email me on roy.shelton@dropjawventures.co.uk
Roy Shelton
Managing Partner