Article written by:
Craig Hickey, CFA
Valuation Services Director
At some point in the future, every business will change hands and will not be run by its current owner. A business owner should be proactive in developing the exit strategy and determining the time and circumstances of their exit from the business. When assessing the potential exit opportunities, here are a few options to consider:
Sale to a Strategic Buyer – This exit strategy involves selling your company to a competitor (oftentimes at a premium). Strategic acquirers believe that they will be able to enhance the cash flows of the business through a number of ways – such as further leveraging of technology, elimination of duplicative overhead, greater buying power, etc. The main advantage of this option is that it is the most financially lucrative to the seller (since the acquirer can pay a large premium in anticipation of higher cash flows). However, consideration should be given to the potential for workforce reductions and operational disruptions as a result of the sale. Further, there is a risk that the deal may fall apart during due diligence, which would result in a competitor having detailed strategic information that could negatively impact the business going forward.
Sale to a Financial Buyer – A sale to a financial buyer means the sale to a financial sponsor such as a private equity or holding company that plans to restructure or re-position the company to improve its performance and prepare it for a strategic acquisition. A financial buyer advantage is that they will likely afford the seller an opportunity to stay involved in the business and potentially reap some of the upsides in a future sale to a strategic buyer or IPO. However, it’s important to note that financial buyers will oftentimes fund the transaction by adding a significant amount of debt to the company’s balance sheet. Also, due to lending institutions being involved in the financing, due diligence is likely to be more intense than other exit opportunities.
Management Buyout – As a seller, it may make sense for the people who have helped grow the business be best-suited to take over operations of the company. The advantages of a management buyout are less due diligence requirements and generally a more seamless transition of ownership. However, members of the management team may not have access to the capital required to purchase ownership, which oftentimes leads to seller notes or other financing strategies that extend the length of time to receive transaction proceeds.
Employee Stock Ownership Plan – An ESOP is a qualified retirement plan which allows the employees of a company to become owners of the stock of their employer, while at the same time providing an attractive business succession plan for selling shareholders. Advantages of ESOPs include the potential of realizing certain tax benefits not available through a third-party sale, preserving the company’s legacy as an independent company, the ability to reward employees who helped build the company, and oftentimes a less timely and costly ownership transition when compared to third-party sales. The potential downsides include the inability to demand a synergistic premium (similar to a sale to a financial buyer) and the likelihood of seller financing on at least a portion of the transaction.
Liquidation – For the vast majority of companies, a company’s ongoing operations are worth more than the assemblage of assets. However, for companies that are difficult to sell or are abnormally asset intensive, liquidation offers the most straight forward path to liquidity. However, liquidation results in the lowest transaction proceeds and return on investment when compared with other alternatives.
Exit planning is a process that does not happen overnight. We recommend working with professionals that address the issues important to the business owner as an individual (such as personal and professional goals, finances, and timelines), and then together develop the most effective strategies to reach those goals.