Owners of family and founder-held businesses have many options as they consider the future. That can make it challenging to be aware of all the alternatives and know which is best for their circumstances.
"By entering the process with an open mind and considering the breadth of transaction types possible, owners will have a more complete picture of what the market is willing to bear in both value and terms," says Bob Baltimore, co-head of M&A at Harris Williams.
What's Most Important?
There is never just one answer for how to exit. You can narrow your options by thinking through these considerations:
- Succession: What processes have you put in place to ensure that the business survives into the next generation? How important is it to you that you choose the next set of leaders? Is there a management team ready—either family or professional, outside management—or is there no one likely to take over the business?
- Legacy: Do you have a strong interest in the way the next leaders run the business? How important is it to you that the company's brand and reputation, and in some cases its name, continue unchanged into the future?
- Role: How much of a role do you want to play going forward? Is the future growth of the company important to you? Do you want to benefit financially from its growth in the future?
- Control: Are you prepared to give up economic control of the company? You will likely have the option for operating control in most of the alternatives, but is that enough to offset the potential loss of the controlling ownership stake? Could you co-exist with a minority partner in your business when you and your team have made all the important business decisions to date?
- Liquidity and Taxes: Would you prefer to be paid fully once or receive cash flow over time? Is your estate structured to optimize your taxes accordingly?
What Are My Options?
"Status quo does not mean the business is standing in concrete," notes Bill Watkins, a managing director at Harris Williams. It simply means there's no change of ownership: "Business owners who want liquidity don't necessarily have to sell the business, particularly if they have a succession plan that they are comfortable with, whether that is within the family or involves outside management."
Owners can extract cash, even if they are not actively leading the business. One way to do this is through cash flow. Another is to do a dividend recapitalization every few years. A dividend recapitalization distributes a onetime dividend to company shareholders, funded through debt. The business must then use operational cash flows to service the new debt load. The transaction is not dilutive, and primary shareholders continue to own the business. "This is a strategy best followed over time, so the dividend doesn't prevent the business from taking on additional debt for strategic reasons such as an acquisition," points out Larissa Rozycki, a director.
Overall, a status quo approach is a great option for owners of businesses that are performing well, who feel that legacy is critically important, and who are confident in their succession plan.
A minority sale—or selling a non-controlling equity stake—is a great option when the business has a transformational opportunity and prefers to avoid leverage that could hamstring growth.
In a minority sale, the owner maintains economic and operational control. The partner's investment is usually focused on growth, but the owner can take some liquidity (although not maximize it). The owner has to be open to culturally shifting the business to work with a partner. Finding the right partner is critical, as the partner will add expertise and likely gain board seats and provide increased governance.
The deal may be more complicated to negotiate than a majority or outright sale, says Virgil Jules, a director at Harris Williams. "There are considerations such as anti-dilution protections, the addition of board seats, negotiating the buyer's ability to increase its position over time, and liquidation preferences. Future-state conditions require careful up-front attention."
Jules adds that there is also typically a valuation discount associated with selling a minority stake. Because there is no "control premium" associated with this transaction type, the seller will not achieve a true market valuation for the portion of the business being sold.
A minority sale is a good option when keeping a controlling role in the company is important to you: You've got a vision for the future and you're excited about taking your business to the next level, but you need additional growth capital.
Majority or Outright Sale
"Depending on buyer type, a full or majority sale of the company can be a great option to ensure that employees have ongoing opportunities, and that growth continues," says Watkins. A majority sale involves a controlling equity stake (51%+), while an outright sale sells a 100% equity stake. In either case, the owner loses economic control of the business, but will have the option to maintain strategic and operational control depending on his or her desires.
Watkins says different types of buyers will bring distinct dynamics to the relationship. "A private equity firm, for example, typically buys companies with strong leadership teams and operations, and will want to ensure continuity in both areas. In contrast, a corporate or 'strategic' buyer may seek to integrate your operations into its own, and that integration may present challenges and provide fewer opportunities for founders and current leaders."
In an outright sale, the seller will have limited opportunity, if any, to participate in future upside. The exception is if the seller decides to "roll over" a portion of the sale price into the new company's equity, which is the traditional and preferred structure with a private equity investor. Most importantly for many buyers, a majority or outright sale typically provides a premium valuation and maximizes the owner's liquidity.
Overall, if you think that you've taken the business far, but don't have the team, resources or the personal interest to take it further, Watkins and team say a majority or full sale is a top option.
In an IPO, the shareholders offer all or a portion of the company's stock to the public markets. An IPO is a great option for a certain business in which the public markets are yearning to invest (for example, high-growth businesses or well-known yet still emergent brands).
In contrast, a steady business that is not necessarily the most novel may not find an IPO to be a viable option. An IPO also requires extensive preparation and resources, including post-IPO to ensure the company has ample support and market visibility. Becoming a public company changes the dynamics of the business, as leadership is accountable to public shareholders on a quarterly basis. If going public fits into a company’s strategy, selling to a special-purpose acquisition company, or SPAC, is another way of doing that. Learn more about when and how to work with a SPAC buyer.
An Employee Stock Ownership Plan (ESOP) is a defined contribution retirement plan that owners can use to sell all or a part of the company to their employees. ESOPs are often used as an alternative to a traditional sale to a third party and can provide liquidity to the selling shareholders in a tax-advantaged manner.
An ESOP keeps the company's legacy alive while providing ownership to its employees and enabling the business to continue to operate independently. An ESOP can be a great motivational tool for employees and, if structured appropriately, can help reduce corporate taxes, providing more cash flow for the business to grow. Tax advantages can be significant for companies that sponsor ESOPs and the selling shareholders who opt to transact with them.
The attractiveness of this option is in part determined by the owner's confidence in the succession plan, and the priority he or she places on legacy.
The Right Alternative
As shown in the table, there are advantages and considerations to any exit approach. Defining the goals and parameters for the exit is the right place to start.
"This will allow you to effectively screen strategic alternatives and arrive at a path forward," says Watkins. "In the meantime, succession planning and getting the business in order can never start early enough."