One thing is inevitable when someone enters a business – they will exit at some point in the future. Whether the exit is planned or not, and whether the exit is voluntary or involuntary, it will happen.
Many business owners have a desire to successfully exit their business in the future, but the future feels a long way off. Consequently, contemplation of and planning for a successful exit are never properly addressed. There are many things that can be done to increase the value of the company if they are done well in advance of a potential transaction. We operate under the philosophy that regardless of when you think you will exit, you should start planning for it today. Some of the major items that require attention in this process are structure, timing, due diligence, valuation, impact on operations, and terms.
There are two basic structures of business exits – stock sale or asset sale. A stock sale, also referred to as a partnership or membership interest sale in partnerships and LLCs, means the new owner takes over all of the assets, liabilities, and inherent equity in the firm. An asset sale means that only the assets are acquired and put into a new legal entity, leaving the selling entity to pay off its liabilities and close down its operations. Both types of transactions have pros and cons to the buyer and the seller. Asset sales are much more common in today’s business environment. Family-owned businesses may execute these transactions from one generation to the next.
The timing of the exit can be critical to the result for both the buyer and the seller. If the industry in which the business operates is slow or struggling, it may not be the most opportune time to exit because potential buyers will only be interested in buying distressed companies that are selling for prices far below their worth.
Both the buyer and seller should separately conduct the due diligence required to make both parties involved in the transaction comfortable with each other’s representations. This can be a painful process, especially if the company’s accounting and other books are not in order. The business owner should learn about the buyer and if they are the type of person or entity with which they want to do business and to whom they are comfortable to hand over their pride and joy – their business. The buyer’s due diligence may be sparse or thorough, but will drive towards the same result – is what they are buying really what they thought it was.
What method, metric, or formula should be used to determine the value of the business? This depends on several factors, including the standard valuation for the industry in which the business operates and the intentions of the buyer for the business once they take ownership of it. A multiple of EBITDA (Earnings Before Interest Taxes Depreciation and Amortization) is a common method along with multiples of revenue, net income, units produced, and more. The underlying theme of what someone is willing to pay comes down to the value of the current and future cash flows the business will generate. If the business is in a complementary or synergistic position to the current business of the buyer, then the cash flow model may include more than just what the business can generate, but also how it will help the other related business as well.
What are the intentions of the buyer with your business? The seller has every right to understand the answer to the question. Perhaps the buyer intends to dismantle the business after it is bought and fire all of the employees. Or the buyer may want to drastically change the operating business to add value to other core competencies of the buyer. In addition, the structure of transaction may seriously impede the company from making the progress it should.
The terms of the transaction are obviously important when considering what is best for everyone involved. How the reigns are handed over to the new ownership is part of this consideration. A common practice of a buyer is to require the seller to remain employed with the new company for a minimum of three years and promise to not compete with the company in the future. The structure of the payment for the business can have serious cash flow and taxation implications that need to be addressed before the paperwork is signed. The key is to look at all of the terms of the transaction and make sure they will accomplish the objectives of all parties involved.
Our CFOs have successfully guided owners through many exits. Although the strategies and terms differed with each transaction, the result was always the same – we helped the business owners through every step of the process to maximize the value of the transaction for all parties involved.