Planning Your Exit Strategy

Planning Your Exit Strategy The Decision to Sell Part One in a Series

A series for owners of privately-held businesses The transition of ownership is one of the most difficult processes to confront an owner of a privately-held business. The decisions surrounding these issues will determine what will become of the business to which an owner has dedicated most of their life, and what will be the return on what is likely their largest financial asset. Ironically, for critical decisions such as these, most owners are not well prepared, since they may encounter a transition of ownership only once in a lifetime. An owner s decades of experience at managing a business does little to prepare for the complex tasks surrounding their exit. Should the business be sold? Should there be an outright sale? Sale of a minority interest? IPO? Leveraged ESOP? Recapitalization? When is the right time to sell? How is the business to be valued? What are the impacts from the tax, funding and legal implications of the transaction? How will the employees be treated by the new owner? The nature and structure of the deal itself? How does the process remain confidential? The number and complexity of choices can quickly become overwhelming. Years of transactional experience assisting hundreds of owners of privately-held businesses through successful exit strategies has taught that every situation is unique since each seller will have different objectives. An ideal solution for one owner may be undesirable for another. Optimizing the outcome upon exit depends on a carefully thoughtout and well-planned exit strategy. Preparing the Business for Sale: Addressing issues in valuing and evaluating the business Pre-sale checkup and corrective actions to determining if, indeed the company is ready to sell Putting together the best package and sell side due diligence Employee matters in the transaction setting Who is the Optimal Buyer: The importance of understanding the different types of buyers The benefits of selling to a strategic buyer versus a private equity firm Potentially managing a continuing role in the business Expectations about control Determining the appropriate transaction structure The Deal Process: Managing the process is very different than managing the business Effectively use the proper advisors. Navigating pitfalls throughout negotiations and getting to closing Structuring a tax-efficient sale Life After the Deal: How to effectively handle personal wealth issues after the sale Estate and tax planning considerations Pre-determining the impact of various exit strategy options Part one of this series explores the framework for developing an optimized exit transition. Appropriately identifying objectives and understanding the vital importance of well thought out early planning. matter. The content should not be substituted for individual consultation with professional advisors regarding individual circumstances. 2

Private Company Exit First Part The Decision to Sell, discusses how maximizing of the value at exit begins with a process of understanding the owner s objectives and how those objectives influence who the optimal buyer is, and the best exit strategy. Second Part Preparing the Business for Sale, suggests some tactics to consider as well as mistakes to avoid in preparing for the sale of a private business. Third Part Who is the Optimal Buyer, focuses on seeing the business through the eyes of potential buyers and buyer types and on understanding how their various objectives and value drivers fit with the seller s personal and financial goals. Fouth Part The Deal Process, discusses the process of getting from negotiation to closing and explores ways to avoid pitfalls along the way. Fifth Part Life After the Deal, discusses how to preserve and transfer the wealth generated by the exit from your business. 3

Reasons for transition: why now? Although exit transition is a natural part of any company s life cycle, privately-held business owners need to understand what factors are triggering that process to become an actionable reality. Ownership transfers are initiated for many reasons, most commonly: Retirement 1. Retirement of the primary shareholder 2. Competitive pressures 3. Health issues including death or illness of the owner 4. Financial difficulties 5. Lack of readiness of heirs to take control of the business 6. Desire for liquidity and asset diversification on the part of the primary shareholder Retirement is the most frequently stated reason for ownership transfer. Because they are emotionally as well as financially connected with their organizations, many private business owners are unwilling to seriously investigate opportunities to transition ownership before they are forced to by age or illness. Industry Pressures The second most frequently stated reason for ownership transfer is intensified competition. For many owners, competitive pressures have increased as a result of consolidation, resulting in lower costs and higher market power for competitors due to the benefits of scale. Many industries that in the past have experienced only local or regional competition have become global, with capital flowing to the most promising industry players regardless of their geographic location. Health or Financial Issues Business owners are compelled by external factors to initiate a transition more often than they choose the appropriate timing. Both the death of the owner and financial difficulties of the business are unanticipated events that can drive a transaction. The common theme of these scenarios is that they are generally reactive in nature, which generally yields a suboptimal result. The objective of this series is to educate the potential seller to enable him/her to be proactive - to empower the owner to control the process and optimize the outcome. The transition of ownership and the succession planning are one of the most difficult challenges that an owner of a privately-held business will be confronted with. 4

Understanding goals: an imperative step To properly structure a transition process the objectives and goals of the owner need to be clearly identified in order to achieve a desired outcome to best satisfy those needs. You recently chatted with one of your trusted advisors about your thoughts for the future of your business. Is it time to sell? What s the best option for succession? There is no heir apparent among your children to take over your business someday. Current economy has allowed the business to thrive, so you re thinking of selling soon. Should you? You ve just received an unsolicited offer by a potential buyer with an interesting offer. You ve actually contemplated selling your business in the near future. Should you sell? Is the price fair? Unique factors influence each scenario succession transition differently. Just as the fact pattern of your business and your life is different from all others. Once you have thoroughly defined your objectives and priorities your unique set of facts can lead to an optimal exit strategy. Achieving premium value begins with a clear definition of not only the financial but also the non-financial goals and objectives of the sellers. Do I care to whom I want to sell/transfer the business? Do I want to keep the business in the family? Are there employees or others whom I want to protect or reward? Do I have a clear understanding of what my financial needs are? Does my business have all the necessary managerial infrastructure needed for future support? Asking these types of questions requires an owner to deliberately consider the future strategic direction of the business. Whatever your decision, the only way to choose an exit option that will best meet your needs after the transition, is only through a clear understanding of your personal and business priorities that you can choose the exit options that will best meet your needs. Some of the many questions you will need to ask yourself include: Will I stay on as part of a management transition team? For how long? Do I want to retain a financial stake in the business post-sale? How do I prioritize what is most important to me? Is the transactional sale price paramount or are there other issues of greater importance in creating an exit strategy? 5 4

What drives value: where are you now? In order to value a business you must first understand what the value drivers are. Having those value drivers identified helps to create a more objective assessment of a privately-held business, due to the close ties an owner may have to the identity of the business. The aspects of your business that make your company desirable to a potential buyer are its value drivers. Typical value drivers, both tangible and intangible, may include: Synergies expected from a merger/acquisition Quality and reputation of the business Cash flow and profitability Customer relationships Growth trends for key products and services Distribution network Intellectual property, such as patents, trademarks and brand name First, understanding what those value drivers are allows you to then analyze the strengths of each driver and where there is need for improvement. Input during the assessment process from a trusted third-party advisor is recommended. Many times a privately-held business is overvalued in the owner s mind, or needs upgrading to improve their attractiveness to potential buyers. Recommendations coming out of these transactions may include a changeover of accounting processes, an upgrade in technology to improve cost cutting measures or the securing of certain members of management team for the future growth. Quality of management team Technology People and intellectual capital 6

Impact of the transition: beyond the owner Many privately-held business owners have concerns, or even guilt, regarding the impact a transition and family members will have upon one another. These issues can have complex and far reaching impact and should be addressed early on. Family considerations Due to the nature of family relations, often times there are challenging emotional and philosophical issues to deal with when business succession within the family is a consideration. Many times these issues are more complex and significant than many of the financial or business topics. Therefore, the most sensitive subject matter should be part of the preliminary discussions in determining objectives, even before the other business issues are addressed. Is the business even intended to stay in the family? Employees and the decision to sell The impact of a transition on employees should be taken into consideration for an effective exit strategy. These beneficial management changes also need to be identified and implemented long before the transition occurs. Should there be incentives in place to retain key management personnel to protection for the long term employees? Performance Management Make this an opportunity to assess current trajectory, set new goals, identify HR weaknesses, and take measures to secure appropriately skilled outside talent. A proven track record of strong managerial leadership is a value driver to the business through the confidence it provides potential buyers. Effective Communications Often times, the intent to transfer the business to an immediate family member is the desire of the owner but may not end up being a realistic, sustainable or prudent choice. Discussing these issues with a trusted advisor early in the planning stages, is strongly encouraged. A discussion such as this, is influenced by many factors, including: Life cycle of business Age, desire, capabilities, and past management experience of potential heir(s) Reaction of siblings Management experience Although the intent to transfer the business to an immediate family member is the desire of the owner that may not end up being a realistic, sustainable or prudent choice. At the very earliest stages, it is critical to identify the key individuals who will need to be involved in the process. This helps to prevent speculation and concern among other employees. Additionally, managing the consistency of the message to potential investors is more feasible. Finally, those who have an impact on sustaining the value of the operation of the business, and therefore attractiveness to potential buyers, will likely be those who will be assisting in preparing for a potential transaction. 7 6

Exit strategy options: structuring the transaction By understanding the impact and effectiveness of proper deal structuring early on, a business owner can significantly influence the value of the transaction. The more wellstructured the deal is, the higher the probability of success will be in achieving an owner s transition objectives. Although there are many ways to transfer ownership, the most common are sales/transfers of ownership within the current family or employee group and sales to a third party. Each arrangement is accompanied by a unique set of concerns. Selling/Transferring Ownership Selling to the Family A privately-held business is usually a lifetime of investment and work on the part of the owner. Many times they believe family members or other heirs should be their successors. This can give rise to conflicts such as managers and key employees being leery of new arrangements, fighting amongst other family members not included, and overall concerns about who controls the business. Being aware of these potential disputes early on means a higher chance of resolving these issues. Selling to a Partner or Co-owner When partners or co-owners purchase a business, ownership agreements should include restrictions regarding the circumstances of the transfer, the potential transferees, and the transfer price. Often there are other provisions such as first right of refusal for stock transference. Selling to an Employee Many times it is an employee or group of employees that are the logical choice for succession. Because of their critical role in the success of the business, if they were to not stay after the transition, the value of the business would certainly be adversely affected. Sale to a Third Party The simplest way to transfer ownership is through a divestiture to an outside buyer. Sales to private strategic buyers as well as larger public companies are common transactions. However, the outside sale of stock can have complications and unintended consequences. Utilizing an experienced, FINRA registered broker-dealer gives a breadth of knowledge and experience as well as reduced risk of potential for rights of rescission by the buyer. 8

Timing: is it ever too early? All too many privately-held companies are reactive in nature when it comes to planning an exit strategy. Whether it s because they are caught up in day-to-day operational demands or emotional resistance to letting go of the business, they fail to have a transition plan in place. Selling in a reactive mode will never yield the maximized value of proactive strategic planning. A sufficient time frame (two to five years) allows time for the company and its owner to: Build a proven effective management team to ensure future stability, establish customer and vendor longevity well before any transaction. Clean up financial records & accounting systems to maximize value to seller and potential buyers and reduce potential last minute reduction of enterprise value. Shift the identity of the embedded value away from the owner and onto the organization. Continue to run the business as normal, once the time does come for a sale, without losing value due to reactive distractions. Allows the owner to drive the process due to early and effective planning instead of the potential buyer gaining control. Plan early, which can dramatically increase the leverage a seller will have prior to negotiations with a buyer. Establish an orderly reporting system of metrics for historic indicators. Strategically search for optimal buyers, understand their value drivers and ensure the company s matching attributes are best positioned to maximize value. Critically examine the company s strengths and weaknesses, and adjust perception accordingly. This objective view can then allow for deficits to be addressed and strengths highlighted. Complete a thorough due diligence sellside fire drill to ensure company is detailed for retail. 9

Position your business now Regardless of a particular investment or economic climate, early and thorough planning will optimize value. Proper timing allows the owner to invest in building the strategy, building the team, and managing the process. Early planning allows time to sufficiently understand the strengths of your business and to identify and shore up weaknesses. It allows sufficient time to understand how buyers perceive value. Early planning allows the owner to embed value in the organization and move it away from the individual. And, importantly, even if a sale is contemplated in the near-term, effective planning will allow you to run the business as if you re not going to sell it. Early planning allows time to sufficiently understand the strengths of your business and to identify and shore up weaknesses. Early and effective planning provides the knowledge that will allow you to drive the exit process rather than allowing potential buyers to gain control. Then, as you build your strategy, build your team, and manage the process, you will be better positioned to focus on running your business as the sale process runs its course. Effective planning enhances value in yet another way, even as negotiations for an actual transaction occur - it will allow you to have the best available information to make an informed decision whether to accept an offer or to walk away. 10

Ten tips for making the deal Classic mistakes to avoid Mind the store Many times when an owner becomes involved in a transition process, especially if they are attempting to run the process themselves, it becomes very easy to lose focus on the day-to-day operations of the business and value is lost. Be sure everyone s on the same page Keeping all individuals coordinated throughout the process can be a complex task. Failure to do so only results in the process being delayed. Get the right advisors and the right expertise You are the expert in your business and at running your business. That is why people come to you. When it s time to run an exit process, go to those who are the experts in transactions and at running the transaction process. Manage the business right up until closing Don t make the assumption that a deal is done, until the deal is done! Once you emotionally commit to the transition being complete and have mentally left for the beach, your decision making becomes compromised. Value your business on its own merits Once you hear what another owner got for the sale of their business, you might not be content with a lower offer for your business, even though it may be optimal or appropriate given the circumstances. Every deal is unique, and the stories you hear rarely include information about the many differences between the two businesses. Keep the circle of knowledge as small as possible News of an impending sale can make employees nervous and give competitors the opportunity to take market share away. You don t want someone whispering in someone s ear, You don t want to use them. They re about to be sold. 11

Know that dollars are not the only factors You may be tempted to jump into the deal process upon receiving an offer that looks enticing. However, a promise of more money with more contingencies is not always the preferred route. Take time to understand the present value of structured components of consideration, such as seller paper or earn outs and the associated risks. Investigate whether the potential buyer has a good track record of sticking with original offers. There are many issues to consider: How quickly can they close? Are there financing contingencies? What additional due diligence do they want? In other words, what issues could stop you from signing this deal with this company? Keep your options open Competition is a good thing. It s possible to waste a great deal of time and money in the deal process with a buyer who makes an exciting initial offer but then, late in the game, shows no intention of closing the deal at that price or on those terms. Meanwhile, you may have let other suitors fall away or taken your eye off company operations, only to see the deal fall apart. Speed is good but not for speed s sake. Be up front about potential issues Should a potential buyer find out negative information late in the game, it could result in a significant reduction in the price and could jeopardize the transaction itself. Present yourself and your company well, but remember that numbers and facts that stick are always better than ones that erode. Be prepared Don t rush to market. Lack of adequate preparation before beginning the selling process is always a major pitfall. Optimizing value and getting to closing requires that you put your best foot forward, make your presentation polished and complete, and be prepared for questions. 12