Exit Strategies: How Many Approaches Are There?
All entrepreneurs will one day leave their companies. The only question is whether they will leave on the terms they prefer. The worst-case scenario is a founder who “dies at the desk” and never reaps the financial rewards from the asset they built. In the best-case scenario, the entrepreneur takes stock of the current situation, crafts a careful strategy, executes it well, and reaps the rewards of a lifetime of hard work. To become that second entrepreneur, it’s imperative to understand the rules of the game. This starts with understanding potential exit options and using that knowledge to craft an appropriate strategy.
Exiting from business happens in different ways. The challenge is to realize as much profit as possible or to avoid losses when leaving the company by choosing the most suitable exit strategy.
The experts at Quantive know the various solutions and can evaluate them to identify the exit strategy that best meets your and your business goals.
The Exit Check: Is Your Company Ready for Sale?
Before we get into detail, you must answer this fundamental question: Is my company ready to be sold? To answer this question with a ‘yes,’ the deciding factor is whether the business can continue successful operation without its founder(s). After all, the founder’s vision, competence, and passion were the key factors that drove the company toward success. If the founder proves to be essential to continue the company’s success, then the founder’s exit may prove fatal to the company’s continued operation.
Business Exit: What Are the Options?
There is no general answer as to which strategy is right for you. Depending on how you envision your exit, your options may include:
- Sell to a third party
- Sell to business partners or other business owners
- Sell to employees via an employee stock option plan (ESOP)
- Management buy-out (MBO)
- Sell or transfer ownership (to family or an employee)
- Initial public offering (IPO)
- Recapitalize the business.
Sell to a Third Party
If the business owner has no suitable successor, he or she may decide to sell the business to aÂ third party. To make the business an attractive value and to maximize its selling price, it’s necessary to develop a step-by-step growth plan. Owners get the bulk of the purchase price at closing. This type of exit strategy may be completed faster than others, usually withinÂ a year.
There are three ways to execute this type of deal:
- Sell to a person unrelated to the business. Buyers are typically looking for a way to become business owners and have management experience and enough funds for a 20% down payment. On the other hand, the deal may take longer to close because of the buyer’s lack of experience.
- Sell to another business in the same industry. In a strategic purchase, buyers pay a high price to acquire the new business/company. The price factor is determined by existing operational systems, economies of scale, administration, service or product offerings, and sales projections. Since these systems are critical to success, they make the target business more attractive to buyers.
- Sell your business to an investor or a private equity group. Bigger businesses and companies (EBITDA of $750,000 or higher) require higher down payments, so private equity groups are more suitable as buyers. They are also able to successfully create economies of scale and drive value due to their diverse company portfolios.
Advantages of selling to a third-party include:
- Geographic market expansion: By taking over a company active in markets that have not yet been covered or only partially covered, this third-party sale can yield the buyer a greater market reach.
- Access to new technologies: In a takeover, technical know-how, inventions, and patents are also transferred to the new owner.
- Vertical expansion: By integrating suppliers or buyers, added value can be generated in the acquisition deal.
- Horizontal expansion: The services and/or products offered can be expanded through new areas of activity, which also diversifies business risk.
- Access to talent: A company takeover usually includes the employees, thus transferring its human capital to the investor.
- Elimination or reduction of competition: A large number of potential investors are interested in the deal, but only one can prevail and thus outperform the direct competition.
Sell to Business Partners or Other Owners
This is one of the most common exit strategies since the partner or owner already has an understanding of the business and a say in business value and its operational strategy. Business owners have the required time to plan and agree to the terms of the sale. The buy-sell agreement between the two parties consists of a plan to deal with potential unplanned and planned triggers that may affect the business. Triggers could be employment termination, disability, retirement, death, bankruptcy, or death.
One of the biggest challenges is agreeing on the business valuation. If the buy-sell agreement has not already been drafted, then it should be drafted as a part of the pre-sale plan. If the agreement already exists, it should be updated as per any new terms. Disagreements crop up when the business partners do not have a consensus on the business value. If the parties are not able to agree to the business valuation, then a third-party appraisal is recommended.
Advantages of this deal type include:
- The buy-sell agreement directs the formula for business valuation.
- The buyer already understands the business and the business stays with a known group of people.
- The sellers benefit from tax reduction, as the buyers want to buy stock in the business.
- In the unfortunate event of a business owner’s death, their life insurance can smooth the way for automatic sale and payment.
- Loans are easily available, as banks are keen to finance the partner’s buy-out.
Management Buy-Out (MBO)
When employees of the company buy “their” business and finance the purchase primarily from their resources, this is known as a management buy-out (MBO). This option has several advantages:
- Motivation: If the decision for this option is made in good time, employee motivation and commitmentÂ increase. People work harder for themselves than for someone else.
- Searching for the next generation: You can recruit qualified executives to share entrepreneurial responsibility, which may achieve a considerable competitive edge through management buy-in.
- Company maintenance: At the same time, the company can be preserved in its existing form.
- Insider knowledge: The buyers already have intimate knowledge of the company’s strengths and weaknesses. As a result, sales negotiations can be made much easier, and the risk of later claims against the seller is significantly reduced.
In principle, MBOs may be considered for any business. Most commonly, MBOs are executed with a high level of outside capital requiring specific financing solutions.
Employee Stock Ownership Plan (ESOP)
An ESOP gives the employee’s ownership interest in the company with the opportunity to buy stock in the business. Ownership shares are given as a part of employee remuneration and share price appreciation. ESOPs may also link to employee performance, prevent hostility, and maintain the company culture.
This exit strategy is complicated and thus preferred by only a select type of business owner. Companies have the freedom to choose who may participate in ESOPs; usually, senior employees receive this benefit, the proportion of the shares determined by their years of service.
Advantages of an ESOP include:
- Employees stay longer with the company, as their ownership shares grow slowly and steadily.
- Since the sale is internal there is little need for due diligence as all the senior employees are well aware of the business’s financial standing.
- The company benefits by making a tax-deductible contribution when they give ESOPs.
- It is a powerful way to inculcate employee productivity and commitment; employees are more motivated and thus more productive.
- The terms of the sale are flexible. Owners can either sell their entire stake in the business, opt for a partial sale, or gradually hand out ESOPs over time.
Sell/Transfer Ownership to Family or an Employee
This exit strategy allows the owners to pay off investors and themselves while securing the company’s continued future because the successor is ideally someone whom the owner has trained and/or trusts to continue the business. Knowing your company is in good hands, you can then retire or start a new venture with fresh capital.
The transfer may be a gift or an outright sale. The biggest drawback of this exit option is that the business might not perform well after the transfer, and if the owner hasn’t received payment, that jeopardizes his or her retirement and financial plans.
Advantages of succession include:
- It ensures business continuity and retains jobs; this means the business does not suddenly cease to operate as before if key positions suddenly become vacant.
- It helps the organization plan for the future, as the next successor is identified well in advance.
- The demand for key positions is met within the organization, reducing the effort, time, and money needed for recruitment.
- If a family member is not interested in taking ownership of the business, then it may be passed to an employee or group of employees, decreasing employee turnover by retaining competent personnel who receive ample growth opportunities within the organization.
Initial Public Offering (IPO)
Strictly speaking, “going public” means nothing more than the reorganization of a partnership into a stock corporation, the shares of which are made available to the public for trade. This allows external equity investors to invest in the company.
In the broader and more common sense, “going public” refers to the initial public offering (IPO) of a corporation: i.e., the first issue of company shares on the organized capital market. One or more investment banks (i.e., underwriters) usually handle an IPO. It’s an efficient way to raise capital for company growth. However, going public entails strict restrictions and reporting standards which can be tough for a private company.
Advantages of an IPO include:
- Since the buyers of an IPO increase the share value, a large amount of capital is created within a short span of time.
- Since IPOs generate publicity, there’s increased awareness of the business.
- The increase in brand awareness also expands the customer base.
Recapitalize the Business
This exit strategy allows the business owner to change the company’s capital by restructuring its debt and equity mixture. An investor buys an interest in the company with a combination of cash and debt financing. The business owner, on the other hand, may diversify the freed capital for other purposes. Owners also realize significant liquidity at the time of recapitalization and later when the investor is ready to sell their ownership share to a strategic partner.
Advantages of recapitalization include:
- A partial sale gives the business owner the much-needed liquidity to secure his or her financial future.
- The new investment partner can help bring in new practices, processes, and/or software that help to make the business more profitable.
- The business can significantly reduce its financial obligations; when the level of debt is reduced, the interest paid to creditors also decreases.
- By swapping equity for debt, recapitalization also keeps the share prices from dropping further.
- Recapitalization helps to reduce tax payments, implement an eventual exit strategy, or prevent the bankruptcy of the business.
Choosing the Right Exit Strategy
The proper exit strategy will lead you toward real growth for your company. Think about your best options as early as possible and get ready to take your business through the process step by step to optimize your chances of finding the “right” buyer and selling your business under the most favorable terms.
There is no one-size-fits-all solution when it comes to business exit strategy. The right exit strategy for your business depends on numerous factors. What really matters is your proactive approach toward your business and personal goals. When you are future-oriented and goal-driven, you are more likely to part from your business on your terms and conditions.