Owners of businesses often reach a natural decision to leave at some point in their career. Giving up ownership to a new party, investor, private equity group or even to the next generation is never an easy task. However planning and preparation could ensure that you don’t miss any crucial steps in the process.
Entrepreneurs leave their businesses for many different reasons.
One of the main drivers is to capitalise on the goodwill and success of the business and divert more time to other interests.
Some people are drawn by the appeal of starting a new business – pushing new boundaries and seeing ideas turned into a new product or service. Like Virgin founder Sir Richard Branson, some people can be drawn by the excitement of building a business, driving its growth, exiting and starting afresh.
And occasionally the unexpected occurs and a death, disability, divorce, illness, bankruptcy, liquidation or some other event necessitates departure.
Anyone looking to buy a business will scrutinise the exit strategy to determine the “real” reasons for an owner’s departure and sale. This forms part of due diligence and may affect the offer price.
The business is often an owner’s biggest asset, reflecting many years of financial and personal contribution, so it is important to obtain maximum value when selling. To do so, a business must demonstrate a solid and sustainable structure with a strong balance sheet, positive cash flow, competitiveness in the market and long-term relationships with stakeholders.
In imagining the future, entrepreneurs see opportunities that others don’t. However, as one entrepreneur commented: “We are fearless risk-takers, but when it comes to financial planning, we have the potential to commit financial suicide.”
This insight only emphasises the need for businesses, particularly those under first-generation ownership, to plan well before they approach the exit point.
Making the transition
The failure to successfully transfer ownership to a buyer or the next generation can deprive entrepreneurs of the ability to build a legacy and create long-term wealth.
Professional advice: Appoint an experienced adviser who can prepare a detailed valuation based on a complete understanding of your business’s financial position, obligations and management.
Clean and consistent accounts: The due diligence process will review both historical financial information and forecasts. Financial statements should reflect the earnings of the business in terms of recognised financial reporting standards, so that potential buyers can understand the profitability, cash flow and financial position.
Document key relationships: No business can expect to be successful without the transition of relationships between key employees, customers, suppliers and other stakeholders. These relationships have a strong element of personal connection, so it is important to have clear and well-documented agreements in place. Key terms in such contracts include the length of the agreement, obligations and rights concerning change of control of the business and any exclusivity arrangements. For example, if a business has an exclusive contract, ensure that its “exclusivity” is still enforceable in the event of a change in ownership.
Understand revenue, earnings and cash: Revenue growth without profitability or positive cash flow does not always translate into a sustainable valuation. The future earnings of the business will be analysed to determine the sustainability of operations under fluctuating market conditions.
Retain parts of the business: The owners may wish to keep parts of the business, such as brand names, properties or assets. To assist in the valuation, it is important to consider the structure of those parts of the business to be retained and consider how they relate to the parts that will be sold.
Legal documentation: Certain legal documents can affect the valuation of a business and the path to sale. Shareholder agreements, constitutions or trust deeds can cover the rights and obligations of shareholders, funding, structure, management and the overall direction of the business. Robust agreements can help guide the sale process and reduce the potential for conflict. For example, shareholder agreements can provide an exit strategy, ensure stable control of a company and minimise unforeseen challenges in the valuation and sale of a business.
Possible exit strategies
Selling to another market player or a private equity firm, transferring ownership to employees, management or family and listing the business through an initial public offering are all ways to exit a business. But there are many issues that require careful consideration.
Raising equity: Raising venture capital or angel finance is often difficult. Investors are looking for a compelling growth story and strategy to drive revenue and profitability. Angel investors usually look for investments from which they can generate a higher than average rate of return.
Partial sale: The inability to attract a good price for the whole business may lead an owner to sell a partial stake. This can be achieved through partnerships, conditional sales, share placements and option agreements. A structure is often established to allow for the phased transfer of the business based on specific conditions.
Management buy-out or management buy-in: The management team has first-hand knowledge and expertise of any business. However, managers need to resolve issues regarding the structure of the transaction and the raising of funds. Businesses usually perform better after a buy-out than a buy-in, where there is higher risk because the new owners are not as familiar with the business.
Employee share plans: Company founders may decide to sell to employees in order to continue operations and retain identity. Employees often know the business and will remain committed to its sustainability if they can determine its future direction.
Family: Family issues can often lead to disputes. One way to avoid conflict, in the first instance, is to appoint a number of independent directors to the board who can make unbiased decisions about the future of the business.
IPO (initial public offering): Depending on market conditions and growth profile, going public can be an appropriate path to exit for some businesses.
Keeping it in the family
Part of succession planning often involves keeping the business within the family. But it is often difficult to balance family issues with the best interests of the business. Meticulous planning is critical to success.
Keeping ownership within a family is usually more complex as it requires the transfer of wealth, necessitating expert advice on estate and retirement planning, capital gains tax and stamp duty.
Maintaining good communication between family members is important. Wealth realisation and division of assets can often lead to disputes and have a negative effect on the business.
Owners need to have frank and open discussions about succession, to establish a common understanding of anticipated roles, responsibilities and opportunities. This is often part of the challenge as family and individual goals are not always in line with the business’s goals.
Appropriate appointments: Make sure that family values don’t conflict with commercial decisions. More than half of family business owners (58.4 per cent) do not require family members to have outside business experience before joining the business. It’s a privilege, not a right: Family members may not always be the most suitable successor even within a family business. An independent director may be required to undertake performance and remuneration reviews and conflict resolution can be addressed with formal shareholder agreements.
Set up a family council: Good governance helps with decision-making and in the event of business disputes that risk affecting family unity. The family business needs to be managed professionally as part of the company’s management structure to share information, build trust, avoid politics and achieve consensus.
Establish a board of directors: To provide business advice and guidance, give the business greater transparency and accountability, improve corporate decision-making, assess corporate governance and plan without any loss of privacy.
Timing: Set a definite date for the transfer of leadership and control. Develop a conflict-management process as part of any orientation when inducting new family members into the business.