| The Challenge | | | | if they serve to better ensure that the business wealth |
| The Boom-er Bust | | | | will be delivered in the context, amount, time and |
| | | | certainty needed to meet the identified personal goals. |
| According to an article published by Robert Avery of | | | | Positioning Strategies |
| Cornell University in February 2006, "the majority of | | | | Corporate Value Enhancement Strategies |
| boomer wealth is held in 12 million privately owned | | | | The Team should look at the corporate structure and |
| businesses, of which more than 70% are expected to | | | | governance mechanisms to consider whether the |
| change hands in the next 10 to 15 years." Only a | | | | business is optimally positioned for the intended exit. |
| portion of these businesses will successfully "cash out", | | | | For instance, an asset sale from a "C" Corp could |
| because of a fundamental oversupply of sellers. | | | | result in tax obligations at both the corporate and the |
| Key Mistakes Sellers Make | | | | individual levels. Conversion to an "S" Corp may be |
| Business owners make a mistake when they allow | | | | advantageous, but the tax benefits vest over an |
| too little time to complete a properly executed exit | | | | extended period of time. |
| strategy. Another mistake owners make is focusing on | | | | The make-up of the Board and any Advisory Board |
| the "price" while disregarding the terms and structure | | | | may also have an impact on the value perceived by a |
| of an exit transaction. | | | | buyer. Management strength is considered below. |
| Other key mistakes business owners make in exiting | | | | From the standpoints of "scale", "product or market |
| their companies are:o selling to the (only) competitor | | | | diversity", management strength or any number of |
| who approaches themo not using experienced | | | | others, the business may benefit from a combination |
| advisors (hoping to save transaction costs)o setting | | | | with or consolidation into another business prior to its |
| expectations based on personal needs and without | | | | sale. Alternatively, it may be desirable to spin-off one |
| reference to the marketo failing to explore legitimate | | | | or more non-synergistic or non-performing divisions to |
| Positioning strategies | | | | increase profitability or allow greater management |
| Buyers of middle market companies don't "buy jobs" | | | | focus. |
| for themselves in the way that small business buyers | | | | Business Value Enhancement Strategies |
| do, they "invest" with the expectation of a return | | | | Business Value Enhancement Strategies generally |
| commensurate with the risk. Nothing enhances a | | | | influence valuation because of their perceived impact |
| buyer's perception of "value" more than:o evidence of | | | | on risk, growth or profit margins. At the top of many |
| sustainable growtho a capable management as the | | | | buyers' lists is the need to see a strong, experienced |
| key to managing the risk | | | | and motivated management in place. For Financial |
| The Business owner who engages professional | | | | Buyers, this often includes the need to be assured that |
| advisors, plans thoroughly, and negotiates to ensure | | | | management has "skin in the game", typically an equity |
| that the wealth transfer mechanism chosen most | | | | interest. |
| closely delivers on his goals, is the business owner | | | | Improvements in profit margins are strongest when |
| who will have executed the optimal exit strategy. | | | | they are reflected in trailing (historical) earnings. More |
| Characteristics which Appeal to Buyers | | | | recently effected changes, or even planned changes, |
| If the fundamental laws of risk and reward prevail, only | | | | can also influence valuation, however, if the benefit of |
| the least risky and most profitable businesses will | | | | the changes can be quantified and demonstrated. |
| change hands successfully. With buyers focusing on | | | | Because of the "multiplier effect" built into |
| businesses which represent good investments capable | | | | earnings-based valuations, a $1mm earnings |
| of operating with little or no dependence on their | | | | improvement may increase the valuation by, say, |
| owners, the following characteristics will be seen as | | | | $5mm. |
| desirable:o Businesses which have scaled beyond a | | | | It doesn't seem entirely logical that an exiting business |
| total dependence on the ownero proprietary products, | | | | owner would have unexplored opportunities available |
| services or processeso strong, remaining | | | | for making improvements to the business. It's a little like |
| managemento defensible, differentiated market | | | | living with an outdated kitchen and upgrading just |
| positiono stable, diverse customer baseo recurring | | | | before selling the house. As in the real estate analogy, |
| revenue business modelo business growth | | | | the stakes are higher at the time of exit, and the focus |
| (opportunities)o strong operating marginso manageable | | | | on marketability and valuation greater, so these |
| business risko quality business & accounting | | | | opportunities often do exist.. |
| systemso audited annual and timely internal monthly | | | | Other Business Value Enhancement Strategies |
| financial statements | | | | include:o Reviewing & Revising the Revenue and |
| Defining the Exit | | | | or Business Modelso Implementing Product / Market |
| Exiting is more than selling | | | | Enhancement Planso Expanding & Diversifying the |
| Exit Planning is a process involving the development | | | | Customer Baseo Securing title to Patents & |
| and execution of a series of systematic steps taken | | | | Intellectual Propertyo Commissioning of Financial & |
| to allow both the owner and the "accumulated wealth" | | | | Operational Auditso Strengthening or upgrading of |
| to be extracted from the business, via one or more of | | | | Systems & Procedureso Documenting or |
| the numerous available strategies, including:o Selling the | | | | codifying Contractual Relationships (employees, |
| business to Partners, Strategic Buyers, Investors, | | | | vendors, customers, debt) |
| Competitors, International Buyers, or the Publico | | | | Business Marketability Enhancement Strategies |
| Recapitalizing the business for Partial Liquidityo Merging | | | | If growth opportunity, managed risk and strong margins |
| the business to achieve enhance valuation and/or | | | | are the foundation for building value enhancement |
| marketabilityo Transferring the business to Family, | | | | strategies, then "clarity, transparency and certainty" are |
| Management or Employeeso Gifting the business to | | | | the engines which drive marketability. Business |
| meet personal and/or tax planning goalso Liquidating or | | | | performance is clearly reported and accounted for, |
| Partially Liquidating the business | | | | activities and status are transparent to the buyer, and |
| Exiting is a Process, not an Event | | | | all information portrays a level of certainty about the |
| The Optimal Exit will be achieved through the | | | | future. |
| implementation of a managed process which includes:o | | | | Experienced buyers know that completing acquisitions |
| Establishing a business valuation reference pointo | | | | is a time-consuming and expensive exercise. Buyers |
| Clarifying "Life-after-Business" Goalso Working with a | | | | will perceive greater clarity, transparency and certainty, |
| Team of Specialist Advisorso Preparing a written | | | | and therefore be more motivated to engage, when |
| Plano Identifying and evaluating the applicable | | | | the seller has:o Audited Financial Statementso A |
| Alternative Strategies (Options)o Executing any | | | | Business Plan with a clearly defined growth patho An |
| necessary Positioning or Preliminary Strategieso | | | | in-place sector-experienced Managemento Current |
| Executing the selected Exit Strategy | | | | Market metrics and Analysis |
| Exiting is a complex subject with many moving parts. | | | | Multi-Step Liquidation Strategies |
| No single advisor is an expert in all aspects, so the | | | | Reference is made above to the "risk-reward |
| process should involve inputs from a team of | | | | paradigm". This fundamental reality plays out in ways |
| experienced advisors, and should address the possible | | | | too numerous to mention, including strategies elected |
| need to re-position the business before going to | | | | by business owners to both (A) take cash off the |
| market. | | | | table to reduce risk / exposure as in a re-cap, and (B) |
| Setting Goals | | | | assume reasonable risks for an enhanced valuation as |
| Don't Pick a Play until you know the Endgame | | | | in an earn-out structure. Consider:o The lowest price is |
| The Exit Strategy begins with the M&A Advisor | | | | an all cash price (not often available in today's |
| providing a likely range of the pricing, terms and | | | | market)o Waiting before selling is riskyo Participating in |
| structure expected from a sale in the current market. | | | | an industry consolidation or roll-up increases the risks |
| The Financial Planner or Wealth Manager then | | | | and uncertainty of an exit, but potentially enhances |
| develops a plan to invest the after-tax wealth | | | | marketability and yields a greater valuation |
| extracted from the business to meet lifestyle and | | | | A classic two-stage exit is accomplished by means of |
| life-after-business goals. | | | | a "re-capitalization" in which an investor / partner / |
| For the majority of business owners, this newly | | | | buyer acquires part of the business with an |
| liquidated "business wealth" will constitute a meaningful | | | | expectation to either buy the rest of the business or to |
| portion of the total wealth driving the financial, tax and | | | | market the business in cooperation with the remaining |
| estate plans. The key, then, to beginning the exit | | | | owner at a later time and at a greater valuation. The |
| planning process, is to clarify the endgame, taking into | | | | owner "takes some chips off the table", but retains a |
| account the likely value of extracted business wealth.o | | | | stake, and usually continues to participate in |
| Legacy Goals - what will have been your | | | | management. |
| contribution?o Lifestyle & "Life-after-Business" | | | | Merging the business into one or more other |
| Goals - what do you want from the next phase of | | | | businesses before exiting can lead to increased |
| your life?o Estate Planning Goals - how will you ensure | | | | marketability and even an improved valuation |
| that your estate passes to your heirs in the most tax | | | | sometimes referred to as "multiple bump". Consider a |
| efficient way?o Exit Strategy Goals - based on all of | | | | $20mm revenue business with earnings of $3mm |
| the above, what are the priorities to be met by your | | | | which commands a valuation of $15mm (or a 5 |
| selected exit strategy as to risk, time, wealth and | | | | multiple). Combining that business into a $100mm |
| income? | | | | business with earnings of $15mm and which |
| Selecting a Team | | | | commands a valuation of $90mm (a multiple of 6), |
| Play the "A" Team | | | | now values the original company's participation at |
| The M&A Advisor should assemble and | | | | $18mm, and the consolidation strategy has yielded a |
| coordinate a team, including existing advisors where | | | | $3mm valuation gain. |
| applicable, that will ensure:o access to all appropriate | | | | Transaction Structuring Strategies |
| options and opportunitieso being fully informed as to | | | | Every step along the complex path of executing an |
| the merits and demerits of proposed strategieso | | | | exit strategy demands access to advice from |
| having expert counsel & representation | | | | professionals who have "been there" and who know |
| The Team must include the necessary knowledge, | | | | the opportunities and the pitfalls. |
| skills and experience in Mergers & Acquisitions, | | | | Even though the structuring of the exit transaction |
| Corporate Law, Taxation and Financial Planning / | | | | comes toward the end of the process, structuring is |
| Wealth Management. It may also include specialists in | | | | included here as a "positioning" strategy because it |
| ESOPs, insurance, personnel and business consulting | | | | impacts the value of the Expected Wealth Transfer. |
| disciplines. | | | | Key structuring considerations include:o Considerations |
| Writing a Plan | | | | of risk and reward (as discussed above)o Tax |
| Planning Precedes a Successful Execution | | | | considerationso What incomes and expenses are |
| "Failing to Plan is Planning to Fail!" Business owners | | | | "included" (i.e. belong to the transacted business)?o |
| should not expect to exit successfully in the next 10 | | | | What assets and liabilities are included or excluded?o |
| years without figuring out how best to exit and what | | | | What pre-transaction liquidation, settlement or exclusion |
| preparatory steps should be taken.... and should not | | | | opportunities exist?o What relationships between |
| assume they can wait until they are "ready". | | | | buyer and seller arise? (employment, advisory, landlord, |
| While the critical execution phase will not be a problem | | | | supplier, partner, etc.) |
| for most take-charge entrepreneur business owners, | | | | The majority of middle-market businesses bought and |
| the planning for an exit will be foreign to them as | | | | sold derive their valuation, at least in part, from cash |
| "exiting" has never been their purpose. Their purpose | | | | flow or earnings. The very key question then arises: |
| has been to create and build, and to consider the exit | | | | "What assets and liabilities are essential to and an |
| (if at all) a "retreat". | | | | integral part of the ongoing enterprise, thereby |
| The M&A Advisor should prepare a written Exit | | | | supporting the established earnings flow?" |
| Plan incorporating (1) a valuation of the business, (2) a | | | | Exit Strategies |
| statement of goals and objectives, (3) a review of | | | | The business owner should have his M&A |
| alternative strategies (options), (4) an analysis of the | | | | Advisor prepare an analysis of the fit and applicability |
| gap between the goals and the options, and (4) | | | | of each of the exit strategy options to the stated |
| strategies for closing the gap. | | | | goals and objectives. Not all options will fit every |
| Reconciling Goals and Options | | | | business or every set of goals. |
| Having established an indication of the Expected | | | | Key qualifications for individual strategies might include: |
| Wealth Transfer (the after-tax proceeds from the | | | | Sale: |
| business exit) on the one hand, and an estimate of the | | | | To Partners; Available funding |
| Targeted Wealth Transfer (the wealth transfer | | | | To Competitor; Manageable confidentiality; synergy |
| required to provide the personal life-after-business | | | | To Strategic Buyer Synergy; identifiable business |
| goals) on the other, the business owner and the Exit | | | | purpose |
| Team must now reconcile the two before selecting | | | | To Financial Buyer; Management; financial performance |
| and implementing an exit strategy. | | | | To International Buyer Scale/size; international |
| Whether or not the expected and targeted wealth | | | | orientation |
| transfer values are the same, the owner should | | | | To the Public Scale; integrity; prospects |
| review all exit options, and should also evaluate a | | | | Re-Capitalize: Growth; Cash flow; leveragability |
| number of "Positioning Strategies" for execution prior | | | | Merge: |
| to implementing an Exit Strategy. | | | | Target(s); strategic fit |
| Reconciliation or "Closing the Gap" is an iterative | | | | Transfer: To Family Capability of transferee |
| process of evaluating combinations of positioning and | | | | To Management; Management strength; commitment |
| exit strategies that will yield a release of wealth (the | | | | & buy-in |
| Expected Wealth Transfer) compatible, as to quality, | | | | To Employees |
| time, value and certainty, with achieving the specified | | | | ** Management; market strength; leveragability Gift |
| goals and the associated "Targeted Wealth Transfer". | | | | **Personal goals |
| Closing the Gap may also involve modification of the | | | | Liquidate: Modest or negative return on assets |
| Targeted Wealth Transfer. | | | | ** Specific qualifications must be met as preconditions |
| BUSINESS VALUATION + POSITIONING | | | | to accessing the designated tax benefits. |
| STRATEGIES = EXPECTED WEALTH TRANSFER | | | | Benefits of a Planned Exit |
| EXPECTED WEALTH TRANSFER ~ TARGETED | | | | The primary purpose of approaching a business exit in |
| WEALTH TRANSFER | | | | a systematic, goal-focused and planned way is to |
| TARGETED WEALTH TRANSFER + EXTERNAL | | | | dramatically increase the likelihood that the outcome |
| WEALTH = TOTAL WEALTH | | | | will be optimal to the stated goals. |
| TOTAL WEALTH ~ PERSONAL GOALS | | | | The employment of a team of professional and |
| Where "~" equates Time, Risk/Certainty, Wealth/Value | | | | experienced advisors will add a cost of, say, 3% - 6% |
| & Income | | | | of the wealth transferred, but will potentially add |
| Again, notice that there are two key points of inflection | | | | considerably more value by:o mitigating against a |
| for matching the exit with the personal goals: | | | | failure of the missiono dramatically expediting the |
| 1. the ability to vary the value, timing and certainty | | | | missiono Intermediating the process to eliminate the |
| associated with extracting the business wealth | | | | risks associated with direct negotiations between |
| 2. the ability to vary the timing, risk tolerance, estate | | | | principalso increasing the negotiated value of the |
| wealth, living standards and other variables inherent in | | | | missiono reducing the income tax burdeno helping to |
| the personal goals | | | | reconcile the Expected Wealth Transfer to the |
| A key issue business owners face in considering | | | | Targeted Wealth Transfer |
| "Positioning Strategies" is the very central question of | | | | ... not to mention providing the knowledge and human |
| the "Risk - Reward Paradigm". Positioning strategies | | | | resources to navigate a complex and time-consuming |
| cannot be executed entirely without risk, but | | | | labyrinth of decision making and task execution. |
| manageable risk strategies may deserve consideration | | | | |