Article written by:
Wade Kozich, CPA, CM&AA, CEPA
More business owners are thinking harder about whether this is a good time to monetize their business. There are a few key reasons why this is happening including:
- The aging Baby Boomer demographic. The average age of a Baby Boomer today is 64 years old.
- Eighty to ninety percent of those Baby Boomers’ wealth is tied up in their business. At this point in life, the owner typically wants to de-risk.
- Continued High Valuations. The low yield environment has kept valuations high.
- Fear of the next recession. End of the year 2018 saw a period of increased volatility in the stock markets.
- Owners realize they can “have their cake and eat it too”. Monetize, but stay involved.
The following is a Quick Summary of Options that Business Owners may have to choose from
Option #1: Outright Sale of your business to a Strategic-type Buyer
This is usually the best path when you want to maximize current liquidity and eliminate your risks associated with the business.
A sale to a strategic buyer is usually best when the owner is ready to pack it in, retire and stop worrying about the business and wants to sell 100%. It is often thought to maximize the sale price due to inherent synergies between the buyer and the seller.
Option #2: Sale of All or Part of your Business to a Private Equity-type Buyer
While this has many of the same attributes as a sale to a strategic buyer, a sale to a private equity buyer can render a similar sale price, but also allows the owner/seller to maintain a stake in the business and get that “second bite of the apple”. Typically, a seller to a private equity buyer will roll something like 20% of the sale price and usually will get more value over the long term. Quite often this ‘second bite of the apple” can amount to more than the first bite.
To qualify to be a seller to private equity buyer, the owner should plan on sticking around for a while, at least during a year or two transition period. Also, having a second, strong person on board to run the business is a major plus, if the seller/owner wants to become a passive owner.
Observation: in our world, I would say at least 80% + of our deals fit into Option #1 or #2 with the deals being split equally between strategic buyer and private equity buyers. Also, keep in mind that a strategic buyer for your business may also be owned by a private equity firm.
Option #3: Sale to an ESOP
ESOP can be a great option for certain business owners and are becoming increasingly common. We work on over 100 ESOP companies each year.
Boiling it down to its essence, with an ESOP, you are selling your company to the employees in a leveraged transaction, and, in most cases, getting some proceeds at closing — typically, proceeds over a 5 to 7 year period. In order to accomplish this, the company must take on leverage either by taking on bank debt or by the seller carrying the debt.
The biggest benefit, in my opinion, are the tax advantages which can be substantial. In 1974 when the government first established ESOPs, they wanted to promote employee ownership and consequently, provided very substantial tax breaks. These tax breaks come in two ways:
- An owner selling stock in a C Corp can generally defer gain on the sale of that stock if proceeds are then reinvested in Domestic stocks.
- If the Corporation is, or switches, to an S-Corp status post deal, then to the extent that the ESOP owns the SCorp stock, then the company basically becomes a tax-free entity because an ESOP is a retirement plan and, consequently, pays no income tax.
While ESOPs can be a great vehicle, they do have a few drawbacks:
- You may not get the highest value because the DOL requires third party Fair Market valuations to be performed. These valuations do not provide for potential strategic synergies that can be realized by a sale to a strategic buyer.
- You will most likely severely restrict your future upside from the business.
- You will typically need to wait to get your money, usually over a 5 to 7 year period. Consequently, the continued success of the business is required to get you paid.
- The current cost and ongoing costs of doing an ESOP can be substantial, especially for a smaller ESOP deal, and must be considered.
Observation: While I do not have a current statistic on this, my guess is that less than 10%, and maybe less than 5%, of owner liquidity events are accomplished through ESOPs. They seem to fit particularly well when someone has a business that for whatever reason is difficult to sell.
Option #4: Leveraged Recap
A leveraged recap can work well when an owner does not want to sell yet, but wants to get liquidity from the business.
The company in these transactions borrows from someone, usually a bank, and distributes the proceeds to the owner.
Depending on the tax status of the company and its owner, some of these amounts distributed may be taken out tax free.
Basically, with a leveraged recap, the owner is mimicking what a private equity firm would do with the business if they had bought it.
A leveraged recap will work best for the owner who is very confident in the future of their business, does not mind taking on debt and sees a big potential upside, and, consequently, sees high value in retaining their ownership. This can be an effective way for an owner to transfer wealth from the company to their personal balance sheet.
Observation: While a very small percentage of owner liquidity events are accomplished through leveraged recaps, they can be very effective and beneficial.
Option #5: Management or Partner Buy-Out
These can be very good options, but we find are relatively uncommon. The problem we find with these is that management typically has little money, so they argue for a lower buyout price and must usually borrow the money. Also, if management is not financially sophisticated and not properly represented, it can be difficult to complete these transactions.
Observation: These can fit well where the buyer pool for a business is very limited and where Management is very strong. In smaller deals, management may be able to take advantage of SBA financing which fits many of these transactions very well.
Option #6: IPO
For the most part, the IPO market has been replaced by the Private Equity market which has created a very efficient market for most companies. The cost of going Public and the ongoing compliance costs of going public make it prohibitive for all but the very large companies.
Observation: In the last five years, I can think of only one of our clients that has gone public.
Option #7: Family Transfer
While a decent percentage of businesses transition this way, I do not view this as a liquidity option. I view this more as an estate planning tool. Any liquidity created by these would be similar to the dynamics of a management buy-out or leveraged recap described above.
Observation: While these sound good from a legacy, feel good perspective, they are often done for the wrong business reasons. I had one client who turned down a $40 million offer 25 years ago from a strategic buyer, but instead chose to sell the business to his son for a song, only to see the business eventually run into the ground. Sometimes these work out well, but I encourage anyone to go into these with eyes wide open. Legacy is usually important to most business owners but at what cost?
Option #8 Orderly Liquidation
You see this every once in a while when the asset value of a business exceeds the going concern value of the business. This can happen as a result of the business not being successful or when you have a business that has just wound down in a natural fashion and liquidation is the only viable option left.
All of these options must be considered and are not mutually exclusive. We have had one client, in fact, utilize almost every one of these options over a 40-year period including an IPO. Even amongst these options, there can be many variations, so do not assume anything until you fully explore your options.
You have probably spent a good part of your life building the value in your business. Finishing strong and monetizing your life’s work is very important.
Wade Kozich is Senior Director of the Transaction Advisory Services Group at GBQ Partners, LLC. and Liaison to Investment Bank, Footprint Capital, LLC.
GBQ’s Transaction Advisory Group, including Footprint Capital, consists of 13 Core Team members and works on well over 100 transactions per year in capacities ranging from Deal Planning to Value Creation to Due Diligence to Tax Structuring to Valuations to Investment Banking.