What options does a founder have when trying to realise their desired value at exit for a lifetime of work building a viable business?
It is all too common for a business not to achieve the desired value at exit. The anecdote constantly thrown round is that 80% of businesses fail to sell. So, what options does a founder have when trying to realise a lifetime's work spent building a viable business?
The exit is all about de-risking
The exit is all about de-risking, while also addressing founder preferences about remaining active in the running of the business. Be it a consultancy role or a position on the board— more often than not an acquirer may prefer (or insist on) completely buy out the existing ownership so they can have total control over future direction. The various exit options available will now be discussed (in decreasing size order).
Available Exit Options
For the largest companies, an initial public offering is the chosen method to release value and liquidity for private shareholders. Companies at this level have founders who are significantly de-risked with professional boards and therefore fall outside the scope of this article.
An acquisition is difficult to achieve— first you need to find an acquirer and then agree on a price. Often acquirers have considerable power due to a lack of competition and will structure a deal that depends on the future business performance, with the original founders on an earn out typically up to three years. Acquisitions typically happen when there is a significant asset in the business which would be hard for the acquirer to build themselves. For example, market share, product IP, brand loyalty or any other demonstrable competitive advantage. Another reason can be to remove a potential threat.
Alternatively, exit options can be developed internally, which can offer founders and owners a more reliable choice. These come in the form of management buy-outs that can be leveraged using debt from banks or private equity. The debt can be backed by the business itself, meaning the incoming management doesn’t require significant available funds to hand. The option of a management buyout can give a strong sense of ownership to the management team and promote self-reliance in the run up to executing the deal. However, equity management incentive schemes have to be thought through carefully, since they can help retain skilled and committed managers, but will also decrease the settlement to the founder upon completion of the deal. Both sides can be de-risked using a combination of upfront and deferred payments based on the performance of the business. Next generation succession can also be considered a form of a management buy-out.
A variation of a management buy-out is the management buy-in where an outside management team can see the potential of the business and will make an approach. These deals are much harder to prepare for, due to the difficulty of finding a willing external management team. One option is to talk to private equity, who can have a black book of contacts and the network to organise a new team.
The next rung down is employee ownership trusts where founder stock is sold to a trust for the benefit of the employees. Think John Lewis in the UK. These types of deals can offer flexibility in retaining control for a founder and can also be very tax efficient.
Finally, if a business is cashflow positive or it just proves too difficult to find a suitable buyer, the founder can choose not to sell and opt instead to release value over time through a dividend. It will of course be necessary to hire effective management to make the business as self-reliant as possible.
There are several clear steps that a founder needs to take to improve the chances of a successful exit
Improving Exit Opportunities
In order to improve upon 'exit chances' and realise value from any exit option, a founder needs to take a number of clear steps in the run up to an exit opportunity. These can help increase the value of the business by properly demonstrating assets and unique advantages, while reducing the chances of an expensive 11th hour deal collapse by ensuring there are no nasty surprises to be revealed during due diligence.
These steps can fall under several broad categories:
Increase Certainty.Forecasts and pipelines of future revenue need to be as accurate as possible. Business metrics should be compared to competitors or industry benchmarks. Over optimistic forecasts will be indefensible and draw into question the predictability of the business model.
Market/Industry Research.Showing a potential acquirer awareness about the market will provide a platform to argue up a cheeky low bid and demonstrate the founder knows the value of what they are selling.
Assets.Properly stating business assets, IP, value drivers, unique value proposition will provide a solid position of what is on the table and will force an acquirer to think about the difficulty in building similar assets internally.
Risk Analysis.Many fall at this hurdle— being unable to properly identify the weaknesses of a business they have worked so hard to build! However painful it may be to state key weaknesses, it is important to be honest and open. An acquirer will respect this because it reduces the chances of a founder trying to hide drawbacks later on. Risks that arise unexpectedly late in the exit process can be deal killers and cause greater expense for both sides— at the very least a large drop in the offered sale price! The earlier that risks are identified, the more time for each weakness to be fixed or managed. Common weaknesses that are missed include revenue concentration, succession in the management team, capital table complications and upcoming regulatory change. Conducting a thorough risk review prior to beginning a sales process is the single most important step in ensuring smooth sailing and speeding up the sales process.
Hopefully, armed with the insights above, more founders can start with the end in mind, which will significantly improve their chances of a succesful exit and pay-out that meets their expectations.