By: Patrick Ungashick

Selling your company to a strategic buyer…Private equity…ESOPs…IPOs…There seems to be a dizzying list of different ways to exit from your company. You have likely heard of most of them, and perhaps you are considering one versus another. Yet there might be one undervalued exit tactic that you have not heard of and need to know about. It is called a “non-control recap” in short vernacular (recap is an abbreviation of recapitalization). Here’s how it works and why it may help achieve your exit goals.

What is a Non-Control Recap?

Simply put, a non-control recap is selling a minority interest (non-controlling) portion of your company to an investor (recapitalization). Historically for mature companies, non-control investors were largely private equity groups (PEGs), but family offices are an emerging player in this market. Non-control recaps are an alternative to a full sale of the company, although a full sale can still be pursued at a later date.

Why Consider a Non-Control Recap?

This exit tactic offers business owners a number of important advantages, particularly in comparison to selling the entire company. If you are your company’s sole owner, you can gain significant liquidity by taking home cash from the partial sale while continuing as a partial owner and leader of the company. You can reduce personal risk, as you diversify your net worth by gaining cash and potentially reducing or eliminating personal guarantees with an additional equity partner involved. Non-control investors prefer a passive role in the company, leaving you in control of day to day operations and decisions. With the right investor, you gain a valuable strategic ally in growing the company. Non-control investors may bring strategic opportunities to the company that were previously not available, such as opening new markets, introductions to prospective clients, or perhaps identifying and assisting with acquisitions for growth. Non-control investors typically require minority representation on your board, bringing experienced leaders to assist the company to its next level of growth. Finally, you can remain the majority owner of the company until a later date, at which point you may choose to sell the entire company at your full and final exit, gaining another round of personal liquidity.

What If You Have Partners?

If you are not the company’s sole owner but have partners, the advantages of a non-control recap include all of the above, plus flexibility to customize the investment to the needs of individual co-owners. The level of liquidity can be tailored such that each co-owner can decide to sell some to all of his or her interest. The ongoing roles can be customized for each owner as well, permitting some to leave at closing and others to continue working in the company. A non-control recap can also be the vehicle for key management to own a portion of the company going forward, as a retention and incentivization strategy and/or as a stepping stone toward a future full sale of the company to the next generation of employee-owners.

Is There a Catch?

Non-control recaps are not for every owner or every company. Investors look for companies that are profitable, offer strong growth potential, and have capable leadership. While a minority investor remains hands-off mainly in the day to day operations, non-control investors will require supermajority rights on issues like selling the entire company or raising additional capital or debt. Another point to consider: the non-control sale may receive a lower valuation multiple than what might be achieved with a full sale, reflecting the investor’s minority position. However, this potential disadvantage is offset with the opportunity to pocket some liquidity now and retain ownership for the full sale at a later date–hopefully at a higher total valuation after having grown the company to the next level.

Non-control recaps may not be the right tool for every business owner, but they offer compelling advantages that should be considered prior to deciding to sell the entire company. To learn more, review our webinar on this topic called “Cashing Out Without Walking Out” or contact us to discuss your individual situation.

Interesting Items

By: Patrick Ungashick

We occasionally hear business owners say something like, “My exit strategy is to hire a great management team to run the company, so I can step back and just collect a check.” Hiring quality leaders for your business is always desirable. Yet, this tactic on its own will not produce a successful and happy exit for these five reasons:

1.Even with highly capable leaders running your company, you still own the company. A significant portion—perhaps the majority—of your wealth remains locked inside the business. At some point you likely will want to access some or all of your capital tied up in the business. This requires an exit strategy.

2.Hiring excellent leaders may allow you to step out of the day-to-day operations of the company, freeing up a large portion of your time — but only a portion. Total absentee ownership is a fantasy. You will need to continue supervising the team’s performance, reviewing business plans and budgets, and approving major decisions. Reducing your involvement in day-to-day operations may help you pursue other interests, but you remain closely tied to your company.

3.In the real world, things change. At some point the management team that you hired to run the company will change, pulling you back into the company’s operations. If a key leader retires, dies, or quits, you will need to identify and hire a replacement. You might also have to temporarily fill in for the missing leader until the replacement has been hired and trained. Or, if a key leader has subpar job performance, you have to do the work of supervising that person more closely and perhaps terminating him or her. In our experience, losing just one key leader from a carefully-built team makes it frustratingly clear to the owner that you have not exited from the company.

4.As long as you own the company, your risks remain unchanged. Many owners seek to reduce personal and financial risks as part of their exit planning. Even with an excellent leadership team in place, the business’s risks are still your risks. You still have to personally guarantee the business debts where required. If the business gets into financial, tax, human resources, or legal difficulties you are still impacted. Any significant capital expenditures are still your decision and risk. Your personal financial net worth remains highly concentrated within the company. Letting a management team run your company typically does little to reduce your personal and financial risk.

5.Even with a highly capable team running your company for you, at some point you will still need a plan for determining what ultimately happens to your ownership interest in the company. You have only punted the issue. Even if you do nothing until your death, your ownership in your company will still either pass to your heirs, be sold, or be shut down. You still have important goals and objectives to plan and execute.

Hiring a competent leadership team is never a bad idea. A quality team not only drives business success but also creates exit planning flexibility and opens up additional paths for your exit. It allows you to delay exit if you wish. Moreover, a quality team usually increases company value at sale or, if passing the business to your children, provides for a smoother transition. Competent leadership teams help business owners achieve successful exits.

However, hiring the team and sitting back to collect a check is not an exit strategy. You are still an owner with all of the responsibilities, burdens, and challenges that ownership entails. Therefore, you still need an exit plan beyond a highly skilled management team.

To learn how a strong team can prepare your company for sale, and to help you get ready for exit, contact Tim at 772-221-4499 for a complimentary, confidential 45-minute consultation.

By: Patrick Ungashick

Five conversations can put you on the path to a happy and successful exit. These conversations need to be open and honest, revealing your desire to exit the business eventually. They need to be handled intentionally and carefully, with preparation and practice, because there is a real danger you may do more harm than good. Ideally, the conversations need to happen well before you exit (we suggest about five years,) when you still have time to take the right advice coming out of these conversations and put it to use. Waiting until just before you exit to have these conversations negates the opportunity for positive action arising out of them, and risks alienating people who care about you and the business, and feel disrespected for not being included much earlier.

The five conversations are with the following relationships:

1.Yourself

2.Your spouse or partner

3.Your business co-owners (if applicable)

4.Your business co-leaders

5.Your advisors

These five relationships are critical for your exit success. How you approach these relationships—through the conversations you have with them—will go a long way to determine if you exit happily or not. As long as you have not disclosed your exit aspirations with these key relationships, you cannot be entirely honest with them for fear of creating potential problems for you and your company. Your ability to lead the business and work effectively with these relationships will be compromised. You will find yourself making critical exit-related decisions that impact the business, partners, employees, customers, key suppliers or advisors, and your family, keeping them in the dark about your intentions, and where you are trying to lead things. Misalignment, tension, friction, and frustration are nearly certain to ensue.

The longer you wait to have these conversations, the greater potential your exit success will be undermined, or you may even cause harm to your relationships with your business partners, employees, customers, and family members. The business may suffer. Millions of dollars may be lost. Consider the following real examples we have encountered, all of which occurred because of business owners who never had a productive exit conversation with these relationships:

• The two business partners who, after 14 years of working together in friendship, found themselves unable to be in the same room out of anger and hurt, because they could not learn how to effectively talk about their future exit.
• The business owner’s wife, sitting in a conference room in our offices, crying out of fear. After thirty years of owning their business, nearly all their wealth was still tied up in the company, and her husband was unwilling or unable to tell her when they would end their financial dependency on the business.
• The three siblings who co-owned a second-generation family business, who prematurely sold the firm because they never learned how to have the exit conversation with each other.
• The two key employees who left the company they cared about as much as the owner, feeling unappreciated and disrespected because they suspected the owner would sell the business one day, but had never confided in them nor approached them about potentially buying it.
• The business owner who did not feel comfortable sharing his future exit intentions with his accountant, and without that information, the accountant failed to recommend a corporate structure that would have reduced taxes at exit by more than five million dollars.
• The business owner who sold his business when a surprise buyer showed up and wrote a large check, even though the owner never had this conversation with himself about his exit goals and values. Only to watch the buyer subsequently treat his former employees and customers poorly to the point that for the rest of the owner’s life, he felt like he had failed those people.

Conversations with the five relationships will not guarantee you a happy and successful exit. However, if you fail to have the conversations with these five relationships, your exit likely will be more stressful, riskier, and costlier than if you have the conversations. To plan these communications takes a modest amount of time. In return, you may create thousands to millions of dollars in increased net business value, years of continued good relationships, and uncountable benefits in reduced stress and avoided problems. On a dollar-for-hour basis, these conversations may be the most valuable time you spend during your entire career as a business owner.

To get started, review this helpful information about the 14 most common exit planning questions. Then, contact us to discuss your specific situation.

If you have a quick question coming out of this article or, if you want to discuss your situation in more detail, we can set up a confidential and complimentary phone consultation at your convenience contact Tim 772-221-4499

By: Patrick Ungashick

Okay, okay, it seems like everybody has used the “like a box of chocolates” metaphor at some point. But in honor of the 25^th anniversary of the movie Forrest Gump (yes, it’s been 25 years!) we are taking our turn. As the full saying goes, “Life is like a box of chocolates. You never know what you’re gonna get.” Planning and preparing for exit is like a box of chocolates in that you too will not know “what you’re gonna get” until you lift that lid and take your first bites. Some of the flavors and textures will pleasantly surprise you, and some you will find distasteful to put it politely. As the owner and leader of a successful company, you probably don’t like a lot of surprises, especially ones that leave you wanting to spit.

Most business owners will only exit once, and therefore have only one shot at success. Because of this, it is imperative to minimize surprises in the process, because anything that catches you off guard can increase stress, raise costs, and undermine or even block your exit success. As a box of chocolates is full of surprises, so too will be your exit. Listed below are ten common exit surprises, followed by a free educational resource on how to avoid each.

1.Your Company Might Not Be Worth What You Think It is

Determining the value of a company is difficult and subjective in nearly all situations. Too often, what you think it is worth will be significantly different from what a potential buyer thinks. Many business owners are unfamiliar with some of the key factors that drive business value and get surprised by what’s important to buyers, and what’s not. Click here to start with our educational articles on what you really need to know about business valuation.

2.If You Sell Your Company, You May Care More About Terms than Price

When exiting, it’s understandable to focus heavily on the total price your company may receive upon sale. However, you may get surprised to learn that terms will be just as important to you—and perhaps more important than price. Most commonly, how much cash is in the deal may matter and determine to whom you sell more than the total sale amount. Read here to understand why.

3.Legacy is So Powerful It Can Veto Price

Many exiting owners are surprised to discover late in the exit process that their legacy aspirations are just as important to them as their financial goals. In some cases, legacy is so important it vetoes price—meaning you might end up picking the buyer who did not offer the highest price but instead offered a good price plus a strong fit with your values. Many if not most owners are not fully in touch with the legacy goals they want to achieve at exit—start here to begin exploring this critical topic.

4.Exiting Changes Things at Home Way More than You Might Expect

Perhaps the biggest surprise for many owners occurs after you exit, and it happens at home. Exit often radically changes personal lives: family routines shift, social relationships develop, personal financial pictures are redrawn, and so on. Many owners and their spouses are caught off guard by these changes, which can be disorienting no matter how much you sold the company for. This free and previously recorded webinar helps prepare you for what to expect.

5.Reaching Financial Freedom Ain’t Easy

The number one goal for most owners at exit is to reach financial freedom—meaning working is a choice and not an economic necessity. Reaching financial freedom and staying financially free after exit is not easy, regardless of how large and valuable your company may be. First, you have to clear enough money at exit (after considerable costs and probably the largest tax bill you’ll ever pay), and second, you will have to manage and invest that money sufficiently well to replace all the income you enjoyed prior to exit. Many owners underestimate what is required here. To learn more, start with this helpful article.

6.Getting Ready for Exit Takes Way Longer than You Expect

This may be the most commonly encountered surprise on the list—preparing yourself, and your company for the future exit takes far longer than you expect. Typically, there are dozens of issues and projects (some large and some small) that need to be evaluated and addressed to prepare you and your organization for the actual exit event. With most of these issues and projects, you and your leadership team will have little to no experience because you’ve never exited before. All of this work must be done on top of running and growing your company—in essence, you will have two critically important jobs at the same time. To help, download this free ebook.

7.To Exit Successfully, Do Not Go Out on Top

Our society preaches “going out on top.” Yet to many owner’s surprises, this does not often apply at exit. It may be advantageous not to exit on top, but rather before the company reaches its next performance peak. Buyers want a company that has not peaked, but instead still offers a credible, sustainable upward growth trajectory. It is difficult to time this properly, and even more challenging to exit from a company in the middle of a profitable, fun, and exciting growth period. To better understand why, read here.

8.The Actual Process of Selling a Company is Full of Surprises

If you have never sold a company before, you will encounter unfamiliar and sometimes unwelcome surprises at multiple points along the way. You cannot afford to be unprepared, especially when your buyer is more experienced and knows how to use its knowledge against you. This article will help you minimize the surprises and lead you into the process less blind.

9.Your EBITDA May Not Be What You Think It Is

One could argue that your EBITDA, once properly adjusted, is the second most important number you need to know to exit successfully. However, many owners get the nasty surprise of realizing (sometimes late in the process) that their EBITDA is misstated or adjusted incorrectly. This concise article explains why so that you are not caught off guard.

10.Exit Impacts Everything

Often, when owners first start to think about exit, they immediately consider the financial aspects and opportunities. Then, frequently thoughts turn to key people and ideas for what one might do next in life. Those are just some of the issues and people exit impacts. In fact, your exit will affect or change nearly every aspect of your business and personal life. Start your exit planning here to avoid getting surprised by any overlooked item.

Exiting successfully is too important to leave things to chance, or to risk biting into some revolting coconut-boysenberry nougat chocolate morsel. Take the time to be prepared and work with advisors who have helped other owners exit successfully.

If you have a quick question coming out of this article or, if you want to discuss your situation in more detail, we can set up a confidential and complimentary phone consultation at your convenience contact Tim 772-221-4499.

By: Patrick Ungashick

To the surprise of many business owners, there are only four ways to exit from a company. One day, you will either pass your company to family members, sell to an outside buyer, sell to an inside buyer, or shut it down. Those are the only four possible exit strategies. Period. They are:

1)    Pass to family

2)    Sell to Outside Buyer

3)    Sell to Inside Buyer

4)    Shut it Down

Accurately identifying which of these four exit strategies is yours can make or break your exit success. Here’s why.

But wait – What About Other Exit Strategies?

Before explaining why it’s imperative to know which of the four exit strategy is yours, you might need proof that only these four occur. Let’s start with “I never want to exit”—a common sentiment. Saying you never want to exit means, you intend to hold onto the company until you die (or perhaps get very, very sick.) Death is not a strategy—it’s a timing event. If you still own some or all of your business at your end, one of the four outcomes listed above will always happen: your interest in your company will pass down to family or be sold to an outside buyer or be sold to an inside buyer, or the company will be shut down. If you intend to own your company until death, that’s fine, but you still have to determine what happens to your company at that time.

What about the idea of holding onto your company and letting a management team run it while you sit back and deposit distribution checks? This is not an exit strategy either. Having a competent management team that can run your business without you is excellent. It can give you time to do other things and increase your business’s value. But it’s not an exit strategy. You still own the company. You will yet have to figure out one day what happens to it. You still have significant personal wealth tied up in the business that you will want to access at some point. Delegating leadership to a team may be the right tactic for now, but eventually turnover happens; at some point, you will have to get involved back again.

What about ESOPs? Employee stock ownership plans (ESOPs) are not an exit strategy—they are a tool to help sell a company to an inside buyer—the third strategy. What about going public? That’s a way to sell a business to an outside buyer—the second strategy. What about an intentionally defective grantor trust? That is a tactic to pass the company to your family members—the first strategy. The point is that there are many exit tactics and structures out there, but they are all tools to help achieve one of the four exit strategies.

Why it is Crucial to Know Your Exit Strategy

The primary reason to know which of the four exit strategies likely applies to you and your business is that each strategy requires a different and mutually exclusive path to maximize your results. In other words, to implement one strategy, you will need to make decisions and take actions that are incompatible with the other strategies. If you don’t know which strategy is yours (or if you pick the wrong strategy), then you risk making decisions that undermine or outright block exiting successfully. Here are a few examples:

Business Valuation

If your desired exit strategy is to pass your business down to your family (the first strategy), then you must take steps to establish the lowest defensible valuation for your company to reduce potential gift and estate taxes.

In contrast, if you intend to sell your business to an outside buyer (the second strategy), then you will seek to create the highest potential valuation for your company when pursuing potential buyers. These are entirely incompatible courses. And, if you intend to sell your business to an inside buyer (the third strategy) then in some situations you will want a low valuation (again—think taxes) but in other cases, you will benefit from a higher valuation. Not clearly knowing your chosen exit strategy risks making critically wrong decisions that impact the business’s valuation.

Leadership Succession

If you intend to pass your business down to family ( the first strategy) or sell to an inside buyer (the third strategy) it’s not enough to have a strong leadership team—you must also have a successor CEO trained and ready to go. Otherwise, your exit very possibly will fail because when you (presumably the current CEO) leave the company, you will not have anybody to replace you. Compare this with the second strategy, selling your company to an outside buyer. Most of the time, having a successor CEO when selling your business to an outside buyer is helpful but not necessary, because the buyer has its own senior leadership team. So, which exit strategy you adopt will determine how you need to hire and develop your leadership team.

Taking Money Out of the Company to Reach Financial Freedom

A third example involves taking money out of the company before exit. Too many business owners leave too much cash in their company, presumably to be used at some point to fund future growth. If you intend to pass your business down to family (the first strategy), sell to an inside buyer (the third strategy), or shut the company down at your exit (the fourth strategy), in most situations you should maximize distributions from the company at every opportunity to reach your personal financial freedom. In those three exit strategies, there may be little to no liquidity event at your exit. In contrast, if you intend to sell your business to an outside buyer upon exit (the second strategy) then reinvesting smartly in the company to maximize growth may be the best use of cash. Again, which decision you make should be driven by having a clear knowledge of your likely exit strategy.

Conclusion

There are many additional considerations and advantages associated with knowing your best exit strategy: it simplifies getting ready for exit, reduces confusion and stress, and can saves costs. But the most important reason is to avoid the danger of making the wrong decisions for the wrong reasons. To get started, consider our free ebook and begin with determining your ideal exit strategy.

If you have a quick question coming out of this article or, if you want to discuss your situation in more detail, we can set up a confidential and complimentary phone consultation at your convenience contact Tim 772-221-4499.

By: Patrick Ungashick

A common question we hear from business owners anticipating selling their company is, “How do I select an investment banker?” As exit planners, part of our role includes helping business owner clients field a team of advisors that can achieve a successful exit. If you intend to sell your company to an outside buyer, an investment banker (or M&A advisor, business broker, etc.) likely plays an important role. Because many business owners have never been through a transaction, knowing what to look for in an investment banker may be new and unfamiliar territory. But selecting the right banker is essential because the wrong choice can cost you thousands to perhaps millions of lost dollars, and/or consume up to a year or more of lost time.

In exit planning and our experience, business owners should apply these five criteria to their search for an investment banking relationship that best fits their situation, needs, and goals:

1. The Banker’s Typical Deal Size = Your Company Value

Select an investment banker that routinely works with companies of similar value to your business. A banker who typically works with companies around $10-20 million in value may not be the best choice if your business is worth $200 million, and the reverse. If your business is significantly larger than the banker’s typical deal size, that professional may lack the experience and resources to represent your company effectively during the sale process. If your business is significantly smaller than the banker’s typical deal size, you may not get the attention and effort required to be successful.

To discern if the size is a good match, ask the investment banker to list the five to ten most recent transactions that he or she directly represented, including company size, industry, and other relevant data. If the banker you are considering is part of a larger team or firm, be sure that the list includes transactions that your investment banker directly worked on, and not a list of deals done by that banker’s colleagues.

2. The Investment Banker Has Experience in Your Industry

Choose an investment banker who has relevant and recent experience in your industry or sector. If your banker has experience in your industry, he or she may need less ramp-up time, bring a more nuanced and sophisticated understanding of industry factors determining value, know relevant industry trends, and have existing relationships with potential buyers. An investment banker lacking experience in your industry cannot match these advantages.

To discern the banker’s industry experience, ask for a sample list of transactions in your space, the banker was directly involved with, and then discuss the particulars. Measure the depth of industry knowledge the banker possesses, especially around market-specific factors such as regulatory issues, competition, key strategic players, or technology trends. The banker might not have to be a guru in your industry, but knowing the landscape and key players goes a long way to successfully representing your company through the sale process.

3. You Understand and Like the Way They Get Paid

In the past, most investment bankers were paid the same way: they charged a monthly retainer fee (designed to help cover their costs and give evidence that the business owner was serious about selling) and then received a success fee in the form of a commission tied to the sale of the company. The success fee represented the lion’s share of the banker’s income and motivated the banker to make the deal happen. The fee was most commonly expressed as a percentage of the deal value and decreased as the deal size increased. In this manner, the total fee percentage went down as the deal size went up. The most common version of this approach was developed in the 1960s by Wall Street firm Lehman Brothers and is called the Lehman Scale or Lehman Formula.

Modifications and adaptations of the Lehman Scale are still in use today. But, in recent years, a greater variety of compensation methods and models have entered the marketplace. This development creates a challenge for the business owner because you now have to sift through a wider range of models. But, you gain the opportunity to select a compensation philosophy that is consistent with your situation and preferences. For example, some investment bankers completely inverse the declining percentages found in the Lehman Scale, replacing it with a fee schedule where above certain thresholds the applicable percentage actually increases. The logic is that the increasing percentages incent the investment banker to drive the sale price up as high as possible, generating a greater net amount for the seller. Another approach is to charge a flat fee, with little to no variability tied to the sale price. To further complicate matters, monthly retainers can greatly vary in amount from one banker to the next, and some bankers credit the retainer against the success fee, while others do not.

On this issue, meet with multiple bankers to get a feel for which compensation method you prefer. Ask the bankers you interview to explain their method and its justifications. Model the banker’s compensation method in a spreadsheet that calculates the fees at various potential sale prices. Ask your other advisors to evaluate the proposed fees, to be sure they are consistent with market rates.

4. Your Other Advisors Support Your Choice

Selling a company is a team sport. An investment banker plays the lead role in the sale process but needs help and support from the business owners’ other advisors at numerous steps along the way. You should rely on your other advisors to screen and select which investment banker you intend to use, not just to protect your interests but also to make sure that you end up with a team of advisors who work together effectively.

Perhaps the two most important advisors to lean on as you research investment bankers are your exit planner and your deal attorney. Your exit planner should be able to do all the following for you: recommend candidate bankers, research their backgrounds and qualifications, accompany you during interviews, and review their proposals. The exit planner should help you determine which banker is qualified to represent your company and at a fair price.

Your deal attorney plays a critical role in reviewing the services agreement that will govern the contractual and financial relationship between you and the investment banker. Too many business owners sign a services agreement prior to engaging a lawyer with M&A experience—that is a deal attorney. Picking your investment banker before engaging a deal attorney is backward. Select the attorney first, and have him or her review the banker’s agreement before signing it. An attorney experienced in these transactions will know how to limit your risks, protect your interests, hold down fees, and avoid contractual provisions that are not consistent with market norms.

5. You are Comfortable with and Trust the Investment Banker

This last criterion may be subjective, but it is no less important. You will be working regularly and closely with your investment banker for many months during the sale process. This person (or team) will be your constant companion, potentially through difficult and emotional matters. Achieving a successful sale will be considerably more difficult and stressful if you are not comfortable with your banker, and all but impossible if you cannot trust this professional.

Spend time carefully choosing your banker. Interview multiple choices—even if you already have a preferred banker in mind, to have different options to compare and contrast. Ask for and follow up on references. If the investment banker is part of a firm or team, verify who on the team you will be working with during the process. Get to know the person or team well, as they will be “in your foxhole.” You must have confidence and comfort in working with them.

Conclusion

Choosing an investment banker takes care and time. Expect the process of selecting your banker to take several months, starting from when you conduct your first interviews up to signing their services agreement (after your deal lawyer has reviewed it.) Then, the real work begins. Making the right choice puts you on the path to a successful sale and exit. Selecting a banker that is not a good fit for your situation can set you back immeasurably.

If you have a quick question coming out of this article or, if you want to discuss your situation in more detail, we can set up a confidential and complimentary phone consultation at your convenience contact Tim 772-221-4499.

Imagine a potential buyer — let’s call them Buyer A — has just offered  $20 million all-cash to acquire your company. Another potential buyer — let’s call them Buyer B — also offers $20 million, but their offer is paid out in equal installments over a period of 10 years.

If nothing else differed between the two offers, which would you choose? Most would take the $20 million paid up front from Buyer A, rather than wait to get paid by Buyer B and take the risk that some of those future payments might never occur.

That much is pretty clear. But what if Buyer B increased their offer to $25 million, still payable over 10 years? Would the $5 million increase in total price outweigh the need and risk to wait to be fully paid? If you would still choose Buyer A’s $20 million all-cash offer, then what if Buyer B upped the offer to $30 million? Then which would you choose?

Different Buyers Will Offer Different Prices and Terms

This hypothetical exercise may seem over simplistic, but it’s quite relevant in the real world. When selling your company at exit, different buyers will not only offer different prices, but they will also offer different terms.

There are a wide variety of potential differences in terms. In the example above, Buyer B offered a different payment schedule — time was the difference between the two offers.

But buyers can use a complex array of different terms. They can vary the currency they use in their offer: cash, stock, notes, etc.

Buyers can also vary the deal requirements, such as whether or not they require you to stay involved with the company for some period of time post-sale and/or if you must sign a non-compete agreement.

Put all these pieces together and the picture can get complicated very quickly. Comparing different prices from different buyers is easy; comparing different sets of terms can be arbitrary and difficult.

If you eventually sell your business at exit, don’t be surprised if you find yourself more concerned about the deal’s terms than about the total purchase price. In other words, the highest-priced offer to buy your company might not be the winning bid. Many owners who have the opportunity to choose from multiple offers select the buyer with the most attractive terms, rather than the buyer paying the highest total price.

Strengthen Your Company Before You’re Ready to Sell

This issue is important now, even if you are not planning on selling your company for a while. Buyers often use deal terms to address a perceived weakness in the target company. Knowing the reasons for these deal terms gives you the information you need to rectify any potential such perceived weaknesses and set yourself up for favorable terms when you do finally sell.

Here are a few common examples:

• A buyer might hold back cash and require an earnout in the offer price when the buyer is not convinced that the company future growth’s will be as robust as the seller forecasts. The buyer’s doubts might be created by inconsistent or subpar growth rates or by a business plan that is unclear or unconvincing.
• A buyer might insist as part of its terms that you must remain with the company for a designated period of time post-sale if that buyer has concerns about the company’s leadership team performing well without you. (Ask us how to overcome this.)
• A buyer might hold back cash in an escrow account if your company has a small number of large customers, any one of which could leave as a result of the company sale.

To minimize the risk that you will be forced to accept burdensome terms when you sell your company, it is important to work on strengthening the company’s value well before you are ready to sell.

It can take several years to address the issues within a company that lead to less than favorable deal terms at sale. Getting started now puts you in the driver’s seat, driving toward the best of both worlds — the highest price AND the most attractive terms.

Your last five years

One of the most common, and important, questions business owners ask is “When should I start my exit planning?”

Your Last Five Years eBook
How the Final 60 Months Will Make or Break Your Exit Success

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To learn more about the steps necessary for a successful exit, contact Tim for a complimentary consultation: 772-221-4499 or email.

Here’s the story of how one business owner’s buy-sell agreement understated his company’s value by a factor of 10, and what you need to know for your own business value and exit planning.

We recently spoke with the majority owner of a professional services firm who has several minority partners. All of them have signed a buy-sell agreement¹, which is typically a good and advisable way to mitigate risk.

The majority owner contacted us because he was suspicious that their agreement was drastically understating the value of his company, and as a result his minority partners were expecting to one day purchase his majority interest at a drastically lower price. He was right to be suspicious.

Book Value Isn’t Always an Important Factor

His company’s buy-sell agreement stipulated a formula of 2.5x book value to determine the overall value for the company. The problem was that for a professional services firm, book value is next to meaningless.

Book value is commonly understood to mean the net value of the company if you simply sell off all the assets and pay off all the debts. Book value therefore ignores the potential value of the company as an ongoing enterprise, including its goodwill.

While book value can be an important factor in asset-heavy industries such as manufacturing and distribution, it usually has little relevance in service-oriented companies. Rather, this owner’s company would ideally be valued based on a multiple of its profits (or revenue in certain circumstances).

Because we have worked with other clients in the same industry, we knew the relative value of his company if he sold to an outside buyer in the open market. That number was about 10 times greater than what his buy-sell agreement stipulated. Needless to say, this majority owner had no intention of selling his company to his two minority partners for a 90% discount, which is exactly what the agreement stated would happen.

The gap between this owner’s market-based business value and what his buy-sell agreement called for was pretty dramatic. However, his situation is common. Many owners are unaware of what their company is worth — according to their own legally-binding buy-sell agreements.

Why Do Such Disparities Happen?

Too often, what the buy-sell says is considerably different than what the company could be worth to an outside buyer, creating the potential for serious problems should the agreement ever be invoked.

This disparity happens for several reasons. First, market conditions change. The value or valuation method used when the buy-sell agreement was written may be considerably different than a value based on current market conditions.

Even if a formula was used, presumably to allow for some change and flexibility, that formula may be out of date. At the speed with which markets change, it can only take a year or two at most for the buy-sell agreement valuation to become a problem.

Second, businesses change rapidly, too. Where your business was and what your business looked like when the buy-sell agreement was written might be materially different from what the company looks like today.

Needs and objectives change with time as well. That’s what happened to this particular business owner. At the time the buy-sell agreement was written, he was trying to get several key employees to buy into the company at an affordable price, thus his advisors wrote a discounted price into the legal document. That may have made sense at the time, but since then his company had dramatically increased in both size and value, making the 2.5x book value approach not only obsolete but even harmful.

How to Maintain a Good Buy-Sell Agreement

What do you need to do with your company’s buy-sell agreement to avoid a similarly contentious situation? Consider these steps:

• Review the agreement no less than annually. Do not let it grow stale.
• Get input from your advisors — not only your attorney (because this is a legal document) and accountant, but also exit planning advisors who can provide perspective and data on current market conditions
• Be flexible. Your buy-sell agreement does not have to apply the same valuation methods to all situations. For example, if you want to sell a portion of your company to a key employee at a lower price, you likely can do so without hard-coding this lower price into every circumstance addressed in the agreement.Also, your buy-sell agreement can apply different valuations to different events. For example, if a minority owner dies, the buy-sell agreement might call for a buy-out of that person’s interest at full price, but if a minority owner is fired for reasonable cause the same buy-sell agreement might apply a deeply penalized, discounted price when buying back those shares.

For more help on this issue and dealing with business partners and co-owners, download our free ebook, Creating Co-Owner Exit Alignment. Or contact us if you have a quick question about your buy-sell agreement.

¹ Also called a shareholder agreement, a buy-sell agreement is a legal document that usually has provisions that predetermine how certain ownership-related situations will be handled, such as the buyout of one or more owners due to death, disability, or other separation from the company. In many situations the buy-sell agreement is a standalone document. However, sometimes the buy-sell provisions are embedded in another legal document, such as the operating agreement in the company if it is an LLC.

To learn more about the steps necessary for a successful exit, contact Tim for a complimentary consultation: 772-221-4499 or email.

Recently we had a client go through a thorough and well-prepared process to sell his company. About 300 potential buyers were contacted — a mix of strategic and financial players. Here’s the preliminary breakdown:

• 300 potential buyers contacted
• 78 were interested/requested further information
• 22 held preliminary phone calls with us
• 9 made an initial offer

If we pause right there, the story might seem strange to many business owners. Only nine out of about 300 qualified buyers made an offer for this profitable, growing, and well-organized company. That’s 3%, which means 97% passed.

To many owners contemplating selling their company, to have so few potential buyers actually step up and make an offer seems surprising and more than slightly disappointing. Yet these numbers are quite typical.

The vast majority of potential buyers at any point in time will not pursue buying your company if contacted because they don’t see a strong fit, are occupied with other acquisitions, are undergoing internal leadership changes, are conserving cash, or any number of other reasons.

Buyers (Usually) Aren’t Crazy, They’re Just Very Different

But this typical client’s experience got even nuttier once the offers came in. Here are the nine offer prices listed from lowest to highest:

$5.9 million

$8.0 million

$12.2 million

$12.3 million

$14.1 million

$14.5 million

$17.5 million

$20.8 million

$32.5 million

How does that happen? How can nine potential buyers, all of whom can do math, produce offers that range from a low of $5.9 million to a high of $32.5 million? Are some of them crazy or incompetent? Are the low offers unjustifiably low — or are the high offers dangerously excessive? Or both?

What is going on here? This company had consistently strong earnings, was growing, and was well led. Why was there so much variation in the buyers’ perception of business value?

Buyers are not crazy — usually. And these results are common. What your company is worth varies greatly from buyer to buyer because each buyer comes with a unique set of needs, challenges, strengths, opportunities, and priorities.

These differences lead buyers to conclude widely different valuations when offering to purchase the company in question. For example, the two buyers with the highest initial offers ($20.8 million and $32.5 million) both had excellent distribution systems and saw a massive opportunity to take our client’s proprietary products into their existing markets, generating highly profitable growth through cross-selling.

The remaining other potential buyers either did not see the same opportunity or were not in a position to capitalize on it. Out of the lowball offers, one potential buyer saw little value in our client’s company beyond its asset base. Another low offer came from a buyer that seemed internally disorganized and thus could not get its act together.

The point here is that buyers are not nuts, they are just very different. Their differences often translate into different conclusions on your company’s value and subjective worth to them.

3 Key Takeaways for Owners Expecting to Sell Their Company

There are several important takeaways for business owners expecting to sell their company at some point in the future. They are listed below, in no particular order, along with additional educational resources from us to help you learn more.

1. Very rarely does it pay to talk to just one buyer at a time because without any comparison, you cannot know if that one buyer is your best option or not. Unfortunately, many owners make this mistake. Buyers know this and try to lure owners into these one-way situations. Watch our webinar to learn more about this issue and to learn when you can safely talk to just one buyer.

2. You must be prepared to run a thorough sales process in order to find your best buyer. This webinar has several real case studies that demonstrate ways to find your “unicorn” buyer.

3. While buyers have different needs and priorities, most buyers agree that certain characteristics make a company more or less valuable. For example, a company that is growing and has a diversified customer base will generally be seen as more valuable than a similarly sized company in the same industry that is shrinking and has a narrower customer base. To learn about 25 factors that can drive company value, download this free tool.

Ultimately, the sooner you start preparing for exit, the more time you’ll have to maximize value in your company and find your best buyer. Contact us to discuss your situation and learn how we have helped other business owners maximize their business value.

To learn more about the steps necessary for a successful exit, contact Tim for a complimentary consultation: 772-221-4499 or email.

If your exit strategy is to pass your business down to the next generation of family members, selling a piece of the company to an outside buyer may surprisingly make a lot of sense as part of your overall exit plan. Normally, keeping the business in the family means just that—preserving family ownership, not selling to an outsider. But selling a minority interest (less than 50%) of the company to an outside investor can help overcome some of the more difficult challenges that family business owners face in their exit and succession planning. Here’s how.

Selling a non-controlling interest in the company to an outside investor, often a private equity group (PEG) or a family office, can solve four problems that commonly arise when trying to achieve a smooth exit for outgoing family owners and prepare the next generation of family owners to lead the company effectively. These four problems include:

1. 1. Liquidity for the Outgoing Owners

One of the most challenging issues to resolve is how to provide financial income and economic freedom for the outgoing owners, whom we will call Dad and Mom. Commonly, Dad and Mom have invested heavily in the company over the years, and consequently, a significant portion of their net worth is tied up in the company and its supporting assets, leaving Dad and Mom unable to retire or step down from the company without somehow obtaining cash from the business. Yet the company typically does not have a large amount of surplus cash sitting around to fund Dad and Mom’s exit. As they lack the cash, the most common solution is keeping Mom and Dad on the payroll well after the next generation has taken over the company. This rarely works for very long. At some point, Dad and Mom may come to resent and/or worry about being continuously dependent on the company. Or, the next generation, whom we will call the Kids, may grow tired of the payroll burden if they do not see any light at the end of the tunnel. Keeping Dad and Mom permanently on the payroll is not a winning solution.

Selling a minority interest of the company to an outside investor presents a more viable solution on how to create financial independence for Dad and Mom. The outside investor’s cash infusion can fund some or all of the outgoing parents’ financial needs, freeing Dad and Mom from staying on the payroll indefinitely and giving them power over their own assets. Meanwhile, the Kids maintain a controlling interest in the company. At a future date, they may pursue buying out the minority investor if they desire to restore 100% family ownership of the company.

2. Eliminating Personal Guarantees

A second significant financial obstacle common within family-owned companies deals with personal guarantees on the company’s commercial or trade debt. Often, Dad and Mom have covered the guarantees up to that point, but the Kids lack the collateral and leadership track record to assume that responsibility when Dad and Mom exit. This scenario puts Dad and Mom in the uncomfortable situation of turning over operational control of the company to the Kids while having to stay on the hook for the financial risk. Few parents will be enthusiastic about that prospect. The Kids have reason to be unhappy too, as they will likely wish to avoid burdening their parents. Also, as long as Dad and Mom provide the personal guarantees, they will have the power to exert influence or control over the company, which is typically a sensitive subject for the Kids. If the issue of personal guarantees remains unaddressed, it can prevent the entire family from achieving a successful exit.

Selling a minority portion of the company to an outside investor, such as a PEG or family office, can eliminate the personal guarantee barrier to exit success. The entrance of an outside investor can give lenders sufficient confidence and collateral to remove their requirement for any personal guarantees. Furthermore, PEGs and family offices can often secure for the company more favorable debt terms and rates due to their experience and long-standing relationships with their preferred lenders.

3. Insufficient Professional Management

One other major challenge within many family businesses is how to inject professional management expertise into the company without surrendering the family’s leadership of the company. This need becomes acute as the company grows and transitions from one ownership generation to the next. You have likely witnessed family-led companies that struggled or perhaps even collapsed because the successor generation lacked sufficient leadership talent and experience to run the company.

Bringing in an outside investor can upgrade the company’s professional management without displacing the family’s controlling interest. First, outside investors will usually occupy several seats on the company’s board of directors. The right investor will fill these seats with quality leaders who enhance the company’s strategic leadership, experience, and industry contacts. Additionally, as part of its investment, the outside investor may provide funds to hire new managers and employees to work for the family owner. Commonly needed positions include an experienced chief financial officer (CFO) and professional sales manager/leader. A significant upgrade in talent and experience at the board and management team level is achieved without undermining the family’s operational control of the company.

4. Objective Advice and Counsel

Within family-owned companies, personal relationships and dynamics can encroach into business matters, blurring communications, responsibilities, and accountabilities. These relationships can harm company growth and prevent Dad, Mom, and the Kids from achieving a smooth exit and succession. Even within well-functioning family relationships, when facing serious business issues, it is difficult to maintain objectivity when there are only family members in the room.

Here, too, an outside investor can add value to the family business as it moves through a succession process. The investor, again through its minority representation on the board, adds the missing third-party objectivity, perspective, and controls. For example, the investor will likely require the company to prepare annual business plans and budgets and periodically review them at the board level. Also, executive compensation—always a touchy subject in a family-owned company—will be set according to market rates and evaluated objectively according to human resources best practices. These types of steps reduce the risk of nepotism and address the concern that family politics will detrimentally influence major business decisions.

Conclusion

For the benefits of succession to materialize, family-owned businesses must work with the “right” investor – one whose values, business model, and expectations align with those of the family. As such, finding the right investor will take time and careful preparation. Ironically, the best way to keep the business in the family may be to sell a piece of the business to somebody outside of the family.

To discuss your unique business, and how to plan for and achieve a successful exit,  Call 772-210-4499  or email Tim to schedule a confidential, complimentary consultation.