Owning a small to medium business (SME) can be a lucrative investment. However, when the time comes to explore new horizons, many owners discover their business is also one of their least liquid assets. It’s not uncommon for even the savviest of business owners to be unsure of the options available to exit a business – let alone which strategy is best suited to their circumstances.
Here, we look at four key exit strategies potentially open to business owners, while also understanding the pros and cons of each as part of a long-term exit plan.
Trade sale
A trade sale for cash can provide the greatest certainty over the exit path.
If you have a profitable business and there is likely to be significant market interest, then we typically recommend a competitive sale process is run to ensure that you achieve the highest price.
Buyers
Seek advice on whether there are any obvious, strategic buyers for your business. A strategic buyer is often a business operating either in the same or an adjacent market which can leverage the strengths of your business to enhance their broader position. This might be, for example, an international operator in your industry who does not yet have its own business operations in Australia.
While you may not have any plans to currently exit your businesses, it is not uncommon for businesses to just be approached by a strategic buyer. If you do receive such an approach, then it is important to seek advice from a specialist advisor to ensure you are being offered a fair price.
If you are approached by a competitor, it’s particularly important that the process is managed carefully. This is because you might need to share confidential information about your business during the due diligence process, including your customer base, key employees, and profit margins. This can expose your business to significant risk if the deal does not proceed.
A sale to a trade buyer can often be the cleanest and easiest exit mechanism and help you realise the highest value for your business. However, some factors that can detract from certainty of the offer include: the potential need to provide warranties and indemnities as part of the sale and purchase consideration; and if part of the sale will be via share consideration, providing earn-outs or vendor finance. These factors can add complexity to the deal. You also should be aware that if you have been actively involved in the business in the years preceding the sale, then the buyer may require you to stay involved with the business for a reasonable period post-sale (periods of two to three years are not uncommon).
The support of experts throughout a trade sale can be the lynchpin that gets the deal done as efficiently as possible, and with the best result.
IPO
An IPO can be a great exit strategy, particularly if your business has strong growth potential but needs capital to grow. This also gives you the opportunity to remain a part of the business. The transition from private to public company however is neither quick nor inexpensive, and not all businesses will be eligible.
Key considerations when looking at an IPO
Advantages of an IPO can include:
- Easier access to equity markets
- Ability to provide your management team incentives through employee share schemes
- The opportunity to ultimately exit your investment on market (although refer caveats below)
- Good exit values in strong market conditions
Despite the advantages, there are a significant number of disadvantages to consider.
An IPO process can be very costly as it includes legal, accounting and broker fees as well as the costs involved with preparing a prospectus. There are also significant ongoing annual expenses include listing fees, company secretary and share registry fees, and board and committee fees.
You will have less control over the business due to the need to comply with ASX-listing or NZX-listing rules. For example, rules governing continuous disclosure and capital raisings. These compliance restrictions can also hamper management’s ability to maintain focus on growing the business.
If you have a significant ownership interest, there is likely to be time restrictions around when you can sell your shares due to escrow provisions. An escrow period of up to 24 months may be imposed by the ASX so that the market has the chance to value the securities.
Even once your escrow period expires, market sentiment might need navigating if you want to exit your interest and still have a significant management involvement in the business.
Finally, when listing on a public stock exchange, you ultimately lose control of the value of your shares. This is creating issues for a number of technology companies at present, with many currently trading at significant discounts to their IPO price.
Private equity
Private equity (PE) firms typically operate a buy-to-sell model, looking for quality businesses that they can grow and add value to and then ultimately sell at a profit. They will often know the likely exit paths at the time of acquiring an interest in the business.
If your business has strong growth potential and you need capital to support that growth, then sourcing private equity can be an excellent choice. Even if your Therefore it can be worth understanding what businesses the private equity firms own.
PE firms and/or investors can provide you with the capital and experienced management know-how to assist you to grow the business and ultimately achieve a higher return from your business interests when you do sell. Therefore, they can be an ideal investment partner while you work to grow your business to later position it for a more lucrative trade sale or IPO. PE can also be a good choice when some shareholders want to continue growing the business, while others wish to exit, as private equity firm can buy out the interests of the exiting shareholders.
If you do sell to private equity, there will be a big focus on growing the business, either organically or through mergers and acquisitions. You need to be prepared for the fact that PE firms are sophisticated investors who will hold you accountable and drive the business hard. It’s likely they will implement financial disciplines to increase operating margins and improve working capital management to generate higher cash flows.
Private equity firms tend to introduce generous incentive programs to reward management teams for performing. That said, they may be less inclined to offer such incentives to you as a co- owner, given that you should already be incentivised to achieve maximum value.
If you do choose to partner with PE, you need to understand, while the firm may not own 100% of the business, it will often seek to gain effective control. Private equity firms will move to replace owner management teams where the business is not performing to expectations.
There are also some private equity houses that specialise in business turnarounds. These firms can also be attractive to partner with if your business has longer-term potential but needs management expertise or funding to deal with shorter-term operational issues.
It is not uncommon for private equity firms to run a dual process in exiting some of their businesses. This often involves running a competitive sale process at the same time as an IPO process to determine which exit mechanism is likely to result in the maximum profit. While a dual process can be costly to run, it can help to ensure maximum value is achieved and can therefore be a good strategy to for business likely to have strong market interest.
Other private investors
Some private investor houses, such as family offices, are willing to invest in businesses to support their growth and are prepared to hold investments long-term, providing they are generating capital growth and/or strong dividend yields. They can be good investment partners if you want capital to grow or facilitate the exit of some shareholders but hold your interest in the business privately in the medium to long term.
Family succession
Family succession has many advantages, including the ability to retain the family legacy that you have either built or maintained.
However, does it make sense to keep the business in the family? Handing over the reins of a business to the next generation of family members may seem like an easy and ethical choice. However, there are critical issues to address.
- You will most likely be transferring the business at a discounted rate. Can you afford to do this and still fund your desired lifestyle / post-sale goals?
- Is there someone in the family with the skills to run the business, without eroding value?
- Is the transfer in the best interests of your whole family? Family dealings can be fertile ground for dispute. Will transferring the business cause issues in the broader family dynamic?
- What impact will or should the transfer have on your broader estate planning?
When undertaking a family succession, it makes sense to consider how assets can be transferred (if necessary) in the most tax effective way. Other issues to be addressed include whether the business leader will remain engaged in the business or if cashflow from the enterprise will play an ongoing role in the incumbent owner’s retirement plans.
Management buyouts
Some business owners like to sell their business to employees. While this may not often yield the highest dollar value, it generally creates the least disruption to the customer base. It also enables you to share some of the rewards with the employees who have worked hard to grow the business with you. However, this can also result in a more seamless exit, given that your buyers should already have a strong understanding of the business. Difficulties can arise when the management team does not have the financial capacity to fully fund the transaction and other funding mechanisms need to be introduced (e.g. vendor finance or external debt).
Liquidation
Another exit option, which is the one that most owners try to avoid, is liquidating their businesses. This means selling your assets and ceasing operations. Unfortunately, sometimes this is the only viable option and can make good commercial sense when a business is incurring losses that cannot be turned around.
To avoid liquidation, you need to make sure that your business is saleable. That is, you need to ensure that you have goodwill that is transferable. Examples of situations where a business lacks transferable goodwill are: if the business is loss-making; if all customer relationships are managed by you and customers are likely to leave when you sell; if the location of your business is particularly attractive however the lease is about to expire. When businesses are lacking transferable goodwill, they can often be very difficult to sell.
The exit plan that is best for you will depend a lot on the nature of your business, its profitability and growth potential and your personal goals and objectives. Regardless of which exit option you choose, to successfully exit your business requires planning ahead. We recommend starting at least three to five years prior to the time you plan to exit, however, some of the most successful business owners began their exit plan when they were first establishing their business. Seeking expert advice can also greatly assist to streamline an exit, maximise your business’s value to achieve the best result on sale, and help with planning your post-sale commitments. The bottom line is that the backing of experts can be the difference between a successful exit at maximum profit and a difficult exit where value is lost.
Contact your local William Buck advisor to discuss your exit plan today.
