What’s Your Exit Strategy?

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In 2007, when a potential investor asked business owner Dan Throop, 61, what his exit strategy was, he responded by saying, “When I’m done with this meeting, I’m going to turn around and walk out the door.” Throop wasn’t kidding, and he soon realized he didn’t understand the investor’s question.

At the time, Throop and his partners ran a systems integration company based in metropolitan Washington, D.C. The company was generating approximately $13 million in revenue.

Later that year, L-3 Communications— a government contractor—took an interest in the business Throop and his partners had built. A representative from L-3 said he thought Throop’s company would be a smart acquisition, but there was no succession plan in place or senior management team.

“L-3 was concerned that if they acquired our business, there was nobody behind me and my primary partner to run it if we left,” Throop said. “So we started to address those concerns with hiring. By 2010, L-3 took another look at us.”

For most business owners, a liquidity transaction is a once-in-a-lifetime event. So, it’s critical to lay out your transaction goals before you begin to court a buyer or investor. For example, do you want to transition your company to your management team so you can retire? Are you looking to sell your business outright so you can take a profit to start a new venture? You owe it to yourself and your employees to consider the goal first. It’s important to consider timelines for retirement, potential impact on employees and preferred forms of payment.

As with any aspect of your company’s work, it’s important to plan ahead if a business transaction is to run smoothly. And be prepared for challenges along the way, such as fickle buyers, changing regulations and turbulent economic cycles.

You can tackle these challenges head on with an internal team, or you can hire a transaction team consisting of legal, tax and financial experts. While maximizing valuation and minimizing risk will be the common goal of each team, an external team can help minimize risk by freeing up your time so you can run your company.

Also, consider this: According to the latest U.S. Census Bureau statistics, there are 5.3 million companies in America with less than 20 employees. As such, many business owners may be multimillionaires on paper but their wealth can be locked in businesses too small to achieve liquidity through a public offering. Pursuing the following steps can help you build an exit strategy that will unlock the value you’ve built in your company.

Consider your 0ptions

Various methods can achieve liquidity. But options for privately held businesses typically include:

  • Sale to a Private Equity Sponsor: Private equity sponsors are cash buyers who close deals quickly and often enable the transfer of partial ownership to family or management. Because they use leverage to finance a deal, they look for growing companies that can support debt.
  • Strategic Sale: A strategic buyer may be a competitor, vendor or any company that could realize synergy. Strategic buyers may pay in cash or stock and often pay more than private equity sponsors if they can increase capacity or access new customers. They may also be less willing to keep existing management.
  • Generational Succession: If a company is in strong financial condition, banks and private capital providers may be willing to lend it money to make a special dividend payment or to repurchase shares from the owners.
  • Employee Stock Ownership Program (ESOP): When a company is financially healthy, banks may lend it money to repurchase shares from the owners and transfer them to a trust for the benefit of employees. This structure has tax advantages that should be weighed against regulatory and financial requirements that a company must manage continually.

Assemble a team

While it’s possible for an in-house group to manage your transaction, first consider their experience. A professional group of advisors and specialists bring experience insiders likely won’t have. The transaction team plays a vital role in obtaining “market” terms and conditions, ensuring a timely process, providing access to capital markets and structuring the deal to create the most favorable tax treatment.

“What we didn’t realize was how much work it would take leading up to a deal,” Throop said. “The due diligence was incredible—we had four people from June to September working full time cranking numbers.”

Maintain profitability

Softening financial performance and missed projections can sour a buyer’s appetite. Sloppy books reflect poorly on a business, too, and may lead to reduced valuations or even a failed transaction.

Be proactive

At the outset, you must cogently describe your business results in an information memorandum (a “resume” of the business) that buyers use to assess a deal. You should analyze any historical data to ensure accuracy and explain swings in the business. A “back of the envelope” financial model may start a deal, but buyers demand detailed projections with realistic assumptions.

Keep moving

A typical deal takes four to six months, putting stress on the seller and key managers. The longer a deal takes, the more time there is for something to go wrong or for word to leak to customers or competitors. While you should carefully prepare for market, it’s critical to keep the process moving once buyers show interest.

Last year, Throop and his partners finally sold their company to L-3. At the time of the sale, Throop’s company was generating approximately $41 million in revenue and employing 50 people.

“Becoming a part of L-3 gave our company far more resources and a culture that has let us keep doing the things that we do best for our clients,” Throop said. “The deal came together because we had smart people advising us.”

About Tim Burke 1 Article
Tim Burke is a director in M&T Bank’s Investment Banking Group. Based in Baltimore, Md., Burke has advised numerous middle-market clients on a broad range of transactions, including company sales, corporate divestitures, acquisitions and private equity and mezzanine capital issuances. He can be reached at tburke@mtb.com.

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