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