- August 10, 2014
- Posted by: Treadstone Management Partners
- Category: Corporate Finance, Mergers & Acquisitions
When an entrepreneur wishes to finally cash out on the business they created, they are faced with an array of different options. Each route is unique in its own right and provides distinctive benefits to the business owner and its employees. Each decision is affected by the nature of the company in regards to its size, industry, and executive structure. By examining the assortment of possibilities, two distinct categories of decisions emerge. These classifications are whether the sale of the business will be to an internal or external source. Detailed below are four prevalent routes, two in each category, seen throughout the marketplace today.
Internal – Management Buyout
A management buyout is a frequented choice by many entrepreneurs wanting to capitalize on their business, but want to pass leadership on to trusted individuals. This option sets forth a range of benefits both for the seller and the company. First off, this choice requires less time and effort on the behalf of the entrepreneur. By selling the business to a manager or management team, there is no need for a hand-holding period for which to teach the new executives the inside operations of the business. By selling to individuals already entrenched in the business, the operations of the business are not halted in any way and the direction of the company is likely to continue in the same path. When selling to the ingrained management team, employees of the company are likely to feel confident in their new executives, which in turn discourages key employees in leaving the company. The advantages of this internal move are numerous; however, there are crucial aspects that can make this decision unappealing. One such aspect is that the seller may not receive a fair market price on their share of the company. For the few individuals of the management team, raising the large amount of capital to suffice for a full buyout is difficult. This thus makes way for the seller to reduce their selling price, issue a sellers note for financing, or the buyers may turn to a leveraged-buyout strategy. Overall a management buyout requires less effort on behalf of the entrepreneur, but may result in the seller receiving a discounted price for their share.
Internal – ESOP (Employee Stock Ownership Program)
Like the management buyout option, taking the route of establishing an ESOP allows the seller to limit the new owners of the company to be only internal employees. This decision raises finances to buyout the entrepreneur by selling the company to a trust in the name of all the employees. ESOPs are a lucrative option because the seller is able to relinquish any percentage of the business they desire, thus allowing them to stay vested in the company or surrender all control. An ESOP also provides great tax advantages to the company and allows for many actions to become tax-deductible like any contribution of stock and the issuance of dividends. A major, nontangible benefit in this option is that it aligns the company’s performance with all employees’ compensation making the success of the organization beneficial for every employee. However, the decision to cash out of your business by creating an ESOP requires a great deal of planning and consultation for it to be successful. Also in issuing an ESOP a price must be estimated for the stock to be set at, which requires a third party to appraise the value of the company. This process can cause the company to be under valued and in turn cause the entrepreneur to receive less than fair market value. If an entrepreneur wants to stay vested in their company and only sell to an internal source, going through the rigorous required steps may prove worthwhile.
External – Outright Third Party Sale
The option to sell your company outright to a third party is the option most entrepreneurs envision when they go to cash out. This path entails finding a company or conglomerate to purchase all parts of the business outright. A total sale is most likely to provide the highest valuation of the company; however, the net proceeds from the sale can be greatly diminished due to many factors including a large tax rate. Selling to a third party is lucrative in the sense that the seller has no more ties financial or otherwise to their company. This allows them to use the capital to start a new venture or retire with no thought of the future of their business. On the other hand the preparation for an acquisition can be large and costly due to acquiring companies requiring a span of due diligence to occur before any action can take place. An outright sale of a company can seem lucrative for any entrepreneur, but preparing for an acquisition and the fees in transaction can outweigh the benefits of a higher market evaluation.
External – Private Equity Recapitalization
Private equity recapitalization is a possibility for entrepreneurs to externally make money on their company, while holding some control for a set amount of time. This option works by selling a substantial amount of your company to a private equity group upfront and a couple of years later selling the rest of your holdings. By selling to an external source, the entrepreneur receives the usual benefit of an increased evaluation. It also allows them, as the executive, to stay on and continue to lead their company as well as use the knowledge and experience the private equity group brings to the table. For a business owner to even have the option of a private equity recapitalization, a private equity group must see established characteristics within the organization. A strong management team and a positive trend in industry and company growth are two crucial measures a private equity group looks for in a private equity recapitalization move. In essence selling your business twice is worthwhile for some entrepreneurs, but for those looking for an immediate out this may not be the correct solution.