Forbes Magazine reveals that over 80% of business owners have a significant portion of their financial assets locked within their companies, and notably, most have little to no exit planning in place. Additionally, a staggering 78% of business owners plan to sell their businesses to fund their retirement.
Considering these statistics, it becomes evident that many business owners might not achieve the retirement they truly deserve.
I understand the challenges that business owners face firsthand. We are often engaged in building our companies and nurturing their growth, leaving little time to consider our exit options, optimal timing, or how to unlock the highest value for a successful exit.
At INSIGHT, we are committed to helping business owners like yourself navigate this crucial phase with confidence. We specialize in offering tailored advice and strategic guidance for those seeking to sell their companies. We have distilled our vast experience in selling companies into two informative blog posts. This first post discusses Exit Options and the second will cover timing and valuation.
EXIT STRATEGIES
Exit strategies will typically come under one of three categories – External, Structured or Succession:
A. External Exit – Strategic Trade Sale
A merger or acquisition is where the ownership of one business is transferred to or merged into another entity. Usually this involves a larger company acquiring or merging with a smaller one, however, this is not always the case.
In the context of exit strategies, the strategic trade sale or merger is the most sought and considered transaction. That is a sale to a buyer who ‘strategically’ extracts more value from the business than can be done on a standalone basis and therefore they are prepared to pay a premium above a financial valuation. With the right buyer and process, the premium is usually the highest and the deal structure the simplest. All mergers and acquisition approaches are bespoke, as each company, culture, sector, value driver and shareholder objectives are different. A merger can be considered a sale as usually there is a controlling and leading party, albeit deal terms are more likely to be shares for shares than cash out.
Buyers or merger partners may be secured either by:
A ‘sweetheart’ approach – a buyer approaches the seller directly. For a buyer this can secure a deal ahead of the competition by putting in a fast and early offer, but sellers may wonder how an ‘open market’ sale would fare.
A private sale – a full auction process can be off-putting to certain buyers and therefore it may be more preferential to market the business in a private sale to a carefully selected few and ask for a premium in doing so.
A full auction process – the market is confidentially researched in full by targeted multi-channel approaches to key decision makers with strategic buyers, alongside Private Equity investors.
Research will carefully identify the best strategic acquirers using a combination of global intelligence tools and tacit knowledge of buyers. Through the synergies and economies of scale available, the business will be worth differing amounts to different buyers, and often it is not the obvious buyers who will gain the most value from a purchase. The optimal purchaser is one who has a strong strategic rational and a concern that one of their competitors is also focused on acquiring.
In all approaches, confidentiality is maintained by a non-disclosure legal agreement before a company name is given. Furthermore, the business is best presented on an ‘offers’ basis to enable the market to decide on value. Ideally a competitive process will be secured with many buyers bidding in an ‘auction’ which will secure the best price. To create the mergers and acquisition environment a crafted Information Memorandum (IM) is the key selling document, backed by a real time data room with the key financials, performance indicators and product details including any Intellectual Property. This creates the transparency to present the business in the best light to the right buyers and therefore to unlock the equity value. Information may be phased to protect confidentiality.
A good corporate M&A adviser will bring research, tacit buyer knowledge, project management, negotiation, confidentiality, and orchestration of all the parties to deliver the successful merger or acquisition. By creating an auction, they can also help leaders secure the best price without being distracted by the process or getting deal fatigue.
Today, there are increasingly complex deal structures in sales, with earn outs and deferred payments. Considering how best to protect these positions is also critical, and expert advice from the start will be crucial. There is also a trend in partial exits or elevator deals which enables owners to both capitalise on their exit and keep a stake and stay in the business game. Partially retaining the seller can also help the buyer take the company to the next level on a de-risked basis, which could result in owning shares with a greater value in the future.
B. Structured Exit – MBO, MBI, VIMBO, BIMBO or EOT
I. MBO, MBI, VIMBO and BIMBO
A Management Buy Out (MBO) occurs when the managers of the business take over its ownership to create an exit strategy for existing shareholders and to create future value for themselves. There are subsets in the buyout approach including MBIs (Management Buy Ins), VIMBOs (Vendor Initiated Management Buy Outs) and BIMBOs (Brought In Management Buy Outs). Each has subtle differences in the type of management team and the way in which finance houses see them from a risk perspective, predominantly preferring management buyout candidates who have both the most experience and can put in their own ‘risk’ money. That is, they are prepared to put their own capital on the line alongside lenders which ensures their commitment.
The method can be overlooked as an exit strategy in favour of the trade sale. This is usually because the management have not been prepared for succession and there is a perception of a higher value from a trade sale. This will be the case if a strategic buyer is found but not always, particularly if the management can secure private equity to aid the transaction. Naturally management may not have the capital that a trade buyer has, and this may limit affordability; a good headline price can be secured by relying on the headroom in the profits of the company. Shareholders may have to ‘loan’ some of the money typically in the form of loan notes (effectively deferred payments) however, a well put together MBO can be extremely rewarding for all involved. It can reward the central managing team and secure the culture of the business as an independent.
For many managers an MBO will be their first step as entrepreneurs and to becoming owners. The mindset of leadership is different, the risks and technicalities greater. Confidence and the right advice are essential to manage the transition. Finance can be derived from many sources ranging from venture capital and private equity to banks and alternative finance providers. Cost and structure will be criteria with debt cheaper than equity; however, a bank will not be as patient as the equity would be, particularly if growth investment is also required. A corporate finance house will model the debt structures; typically, however, funding may be two to three times EBITDA on a loan which also requires a blend of vendor loans, management risk money and company reserves to fund the rest of the valuation.
It is also important that management teams understand that a well governed board will be needed after the deal. To succeed in dynamic markets, most businesses require a clear leader and an accountable CEO or MD, even if each manager may have contributed equally to the buyout and have equal shares. A quality shareholders’ agreement will better help the board govern and answer future questions like how shares will be valued in the future, what will happen on a future exit strategy, for example, whether sh
ares will be offered to management first, or how a dispute between the managers will be handled.
Companies which have the cashflow to service debt with headroom but are slowing down as shareholders lose drive, are prime targets for an MBO. The management team will need a cohesive plan to drive growth, otherwise with the increased cost of debt, slow growth becomes stagnation. Teamwork is critical as change requires cohesion. Any exit strategy or buy out is complex and time consuming. Management may get distracted and therefore a strong advisory team is needed to create alignment between all the parties quickly. Transactions should be fast, otherwise management seeking to buy can end up working against themselves in the day to day improvement of the team performance.
II. Employee Ownership Trust (EOT)
The concept is simple; employees ‘may’ make better owners of companies than shareholders because they work in the business and, as owners, they may care more than they did as staff, thus enhancing growth prospects. In the UK over 200,000 people are employed by employee-owned companies and in the United States the figure is closer to 1 million.
Globally there are variations on the technical structure. However, to examine the UK: the current approach, the Employee Ownership Trust (EOT), was established under the Finance Act 2014 to provide an alternative to third party sales and encourage greater employee ownership which, if tackled correctly, can be a great contributor to both companies and the wider economy. A qualifying EOT is established with a corporate as the trustee of the EOT (the Trustee Company). The shareholders sell their shares to the Trustee Company under a share purchase agreement at market rate, usually with some of the valuation and purchase funded by the company from profits over a period of time.
In the UK the benefits and characteristics are as follows:
All employees are included as beneficiaries. A formula may weigh the allocation towards longer serving and more highly remunerated staff. A qualifying period of up to 12 months can apply for new employees and, at the time of writing, all employees can receive an annual income tax-free bonus of up to £3,600.
The company is run by the management/board which means that the business and brand can stay the same to maintain the shareholders’ legacy. The EOT is entitled to more than 50% of the profits; usually waiving dividend rights, especially until the exiting shareholders have been paid the valuation price.
The valuation is open market and therefore can compete in ‘headline’ number to, for example, a trade sale to a competitor, although the deal structure may be weaker with some of the money paid overtime from profits after tax in the form of vendor loans. Third party debt may also be used. In the UK any sale to an EOT is, at the time of writing, 100% Capital Gains Tax free. Costs are similar, but the process can be less distracting than finding a trade sale.
An EOT is an exit by sale for the shareholders, however, they may still need to create succession for their roles and for an employee-owned business to be successful, investment in cultural transition is also critical. The approach can otherwise be seen purely as a tax exercise by employees.
C. Family Succession and Inheritance
Family succession is when the owner’s shares are ‘gifted’ or sold to the next generation (often over time) as family members develop within the business. In either scenario, a simple process including a business valuation is required before tax advisors assist in the structuring and lawyers in the SPA and ancillary documentation.
Usually, this decision is made on softer issues such as what would family members do if they were not employed by the business, how would staff be treated in the future and legacy. However, as only 30% of family-owned businesses survive the second generation and c.3% survive the fourth generation - the shareholders should carefully reflect on whether succession is the best route for all concerned and whether a trade exit will not
only provide secure employment but also preserve the family’s wealth for future generations.
An argument in response is that currently within the UK, shares in a private company can be tax free so passing on shares on death, depending on the family, can form an important part of succession planning. The thinking: why sell to secure cash we might not need only to then find the family later pay large amounts of inheritance tax. However, this can be protected by a percentage of the proceeds going into a Trust at the point of the closing.
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TYPES OF BUYER
As well as many types of exits there are many types of buyers; being able to understand the best type and the approach of each is important when assessing the transaction and how you handle negotiations on each exit strategy. Each buyer will have different characteristics; overall they can be categorised as follows:
A. Trade ‘strategic’ buyers or mergers
The word ‘strategic’ is used as beyond gaining the financial value of your business, the buyer should also secure some other ‘strategic’ play which adds a premium value to the transaction. It is this aspiration of a premium which many sellers seek. Strategic buyers should feel that there is a natural ‘fit’ and the combination of the two creates new opportunities. There may also be downsides such as redundancies and perhaps loss of the brand, but usually the sum of the two create better businesses, therefore there should be far greater upsides than downsides to this type of transaction for both buying and selling parties.
B. Private Equity (“PE”)
Typically, this is used to refer to specialist ‘partnership firms’ which collectively, via both high-net-worth individuals and intuitional investors, have raised a ‘fund’ to acquire usually pre-stated types and characteristics of businesses. The fund may therefore have a theme, for example, buying or investing in environmental businesses. Limited partners (“LPs”) invest their money into funds that general partners (“GPs”) of the PE firm use to buy companies, typically within a specific industry. The aim of Private Equity is to seek to maximise the growth of the acquired companies over, let’s say, five or more years and ideally to secure a future sale at three to five times the initial purchase price, less debt taken, to get a return for themselves and their investors.
Private Equity firms usually look to maximise the profitability of the business. They should bring capital, financial expertise and corporate acumen. They almost always seek to retain the management team, often the founders, for continuity and industry expertise, usually with these parties retaining a stake to gain further value at the exit. Private Equity works well for high growth potential businesses that need capital to expand. Private Equity will often also add ‘bolt on’ acquisitions to further accelerate growth and value, as they have access to capital which most private companies do not. Some good trade buyers may also be Private Equity buyers, led by the nature of their shareholding. Such companies have both the funding and expertise to acquire via their access to the equity firm. Many sellers dismiss Private Equity transactions too quickly. Their focus is the trade deal where they realise all the value on day one. Trade buyers can, however, be cautious, and will always compare organic growth to a purchase. So for many trade deals values can still be ‘feet firmly on the ground’. Private Equity valuations may compare although a deal may be more structured, and more interestingly there may be a material uplift on the later sale. A Private Equity deal may be the best way to secure a significantly higher value than a trade sale today.
C. Family Offices
Family offices act on behalf of high net-worth individuals or a single wealthy family. They usually have a trade preference of acquiring in sectors they already know or that initially generated their wealth and the focus is usually low risk, highly sustainable businesses. The objective is typically to ensure the family’s wealth for future generations. Family offices are becoming more common as more people achieve ultra-high net wealth status and the tax breaks on family investment are positive in many countries. Values may not be as high as strategic trade deals or Private Equity as often the transaction is designed for long-term holding and securing long-term yield on the business. The office is usually represented by a strong corporate team who have worked with the family for many years.
D. Entrepreneurs and Strategic Investors
These are individuals who see potential in your market or business and are prepared to take on the financial risks of funding a deal in the hope of profit, usually by securing a better deal after growing the venture hands-on. The category can include a lot of people who can tell a great story but need careful vetting; at the same time there are some exceptional entrepreneurs who really know how to buy great companies. Track record and references are essential. If an investor, rather than an outright sale, is sought, leaders and founders should keep in mind that strategic investors buying shares usually leads to reduced control and the investors’ agenda will need to be considered.
E. Management
These individuals are typically your ‘senior team working in the sector’ who ideally will have been prepared in a succession plan to take over. Their ambition is to buy the company then take the business further. Sometimes they are external and brought in specifically for the buyout purpose and often they team up with a Private Equity firm to fund a significant portion of the purchase price.
F. Employee Ownership
Different to management in that all employees are the buyer in a Trust. Great recent examples of sales to employees include Richer Sounds, Aardman Animations and Arbuckles restaurants.
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WHICH EXIT ROUTE SHOULD I CHOOSE?
Selecting the appropriate exit strategy and buyer type for your business involves a careful assessment of various elements, primarily the objectives of the owners and the availability of buyers and capital. Your sale may consider more than one exit strategy and buyer type - making the decision complex and unique to each situation.
The objectives of the owners play a significant role in shaping the ideal exit plan. While some prioritise securing the highest price and best terms, others may prioritise selling the company to family, management, or employees. There are also those who will consider all these factors such as value, terms, and future opportunities for their employees in the round.
Additionally, the availability of buyers and capital within each exit strategy will impact the available options. For instance, if there is already a suitable family or management team in place, the owners will have a prepared exit option, though this sale may affect the overall value and payment period. Finding a common ground on valuation and payment terms becomes essential, and this often depends on the availability of capital, whether it's in the form of debt or equity.
In the case of a strategic trade sale, thorough research and a robust sales process become crucial to identify all potential acquirers. The market's strength and direction at that time will significantly influence the availability of interested buyers and available capital.
Given the complexity of these factors, it's essential for business owners to approach the exit planning process with an open mind. Engaging a corporate financier to assist in detailed market research and preparing the business thoroughly will help identify the best options for the owners and allow for the successful execution of their chosen strategy.
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Undertaking a business sale or succession is one of the most important financial decision a business owner will make. We are here to assist you in selecting the right route for your journey. If you would like to delve deeper into the content of this article and explore how it relates to your specific circumstances, you can book a free consultation with us by checking our availability here. We look forward to discussing your situation in detail and providing personalised guidance based on your needs.
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