When business owners start to think about exiting their companies, the number of possible exit routes can seem limitless, but in fact, there are only eight:
- Transfer the company to family member(s).
- Sell the business to one or more key employees.
- Sell to employees using an Employee Stock Ownership Plan (ESOP).
- Sell to one or more co-owners.
- Sell to an outside third party.
- Engage in an Initial Public Offering (IPO).
- Retain ownership but become a passive owner.
Which of these exits do owners intend to use? A January 31, 2005, survey by PriceWaterhouseCoopers indicates that:
- About one-half anticipate a third-party sale.
- Nearly one-fifth anticipate a transfer to the next generation.
- Fourteen percent anticipate a management buyout.
- Seven percent expect to sell to an ESOP.
- Ten percent anticipate an IPO or other option.
This White Paper examines the advantages and disadvantages of each route and describes a process that enables owners to choose the best exit path for them.
Let’s begin with a fictional company case study.
Ben (55), Tom (45), and Larry (35) purchased Front Range Powder Coating from its former owner in 2004. They paid “book value” or about $1 million. Now, seven years later, they are at a crossroads: Ben, the oldest, is interested in reducing his role in the company and has approached Tom and Larry about purchasing his one-third interest.
But there’s a kicker. Ben is not interested in selling his interest on the same basis as he acquired it—book value. Instead, he wants one- third of the fair market value of the company.
Since the company has increased its book value to $2.5 million and its annual cash flow from $200,000 to more than $2 million, Tom and Larry face a major cash crisis. Should they proceed with the buyout?
As these owners discussed their objectives, it became clear to them, as it does to all owners, that business succession planning has little to do with the characteristics of the business and everything to do with each particular owner’s personal exit objectives.
- Ben wants to exit immediately for fair market value.
- Tom wants to continue to work for a number of years but isn’t too keen on dedicating the company’s entire cash flow to the purchase of Ben’s stock. Tom believes that it is a risky proposition to use cash flow to pay off Ben rather than to fuel future growth. Further, Tom figures that, at just about the time Ben is paid off, it will be his turn to retire (at, he hopes, an even greater value).
- Larry, the youngest, shares Tom’s cash flow concerns, but is sensitive to the desires of several non-owner managers—the next generation of ownership. Several key employees are quietly, but rather insistently, clamoring for ownership or similar ownership- based incentives.
- Larry wants to remain active in the company for the next 15 to 20 years as its principal owner and knows he can’t indefinitely defer meaningful incentives to the key employee group.