Business owners often come to Acuity Advisors when their companies have achieved some level of critical mass or scale. As owners approach the later stages of their working lives, they are often looking for an exit strategy that will maximize the value of what they’ve built. Chris Kramer explores how to nourish that goal throughout the life of the business.
As a business owner, chances are you started your business because you were confident that you could deliver a product or service more effectively than the company you were working for. You might also have started the business to build wealth around something you are passionate about, or maybe you inherited the company after years of learning the business from your parents or grandparents.
In any of these scenarios, at some point you’ll likely be asking yourself some or all of these important questions:
- What is my exit strategy?
- How can I maximize the value of the business?
- What is the best way to monetize the value of what I have built?
- Is it finally time to take some chips off the table?
As a business owner myself, I believe that you should be asking yourself these questions from the moment you become an owner.
The Early Stages: Keep Tabs on What You Have
In the early stages of the business, your vision, creativity, and drive will set the direction, culture, and long-term prospects for the business. From the risk you are willing to take, to the team you hire, to the markets you choose to go after, your decisions will form the foundation of value creation for many years to come.
As you build your team, it will often make sense to reward your key people with equity incentives that could include stock options, outright ownership or restricted stock, or synthetic equity such as Stock Appreciation Rights (SARs), phantom stock, or other similar plans. All of these options have tax and benefit implications that require a credible, independent valuation to maximize their effectiveness, and to be fully compliant with tax law and other regulations.
The Growth Stage: Value Enhancement
As you continue to grow, other key decisions become critical. Should I:
- Invest in research and development?
- Establish new brands?
- Develop new products?
- Try to achieve growth through acquisition?
To assess whether any of these strategies will contribute to long-term value creation, their expected long-term impact should be analyzed and assessed against a current value of your business. This is especially pertinent in the case of an acquisition, where purchase price and other negotiated deal points can have a meaningful bearing on the success of the strategy.
All of these strategies should help to create, improve, or enhance the primary things that virtually all buyers are seeking in acquisition candidates, and the things that they are willing to pay a premium to acquire. They include, but are not limited to a large addressable market, high barriers to entry, management depth and human capital, recurring/sustainable revenues, high margins, and anything that can be considered proprietary. As you build out the team, issuing stock options, phantom stock or SAR’s, or even implementing an Employee Stock Ownership Plan (ESOP) for a portion of the shares can all be effective ways to retain, recruit, and motivate your workforce.
If you focus on these areas, to the extent possible, you will more likely be in a position to attract a significant premium when you are ready to ultimately exit the business. Further, the ability to withstand rigorous scrutiny in due diligence will be significantly enhanced by maintaining complete and orderly legal and other business records, obtaining reviewed or audited financial statements, keeping personal expenses and perquisites well documented, and related party transactions contracted at arms length rates.
Every Stage: Tax Planning and Reduction
No discussion around value enhancement would be complete without discussing the impact of taxes. The old adage “Its not what you earn, but what you keep” is never more true than in the context of a business and maximizing value. Prior to considering your exit, a number of tax related decisions can be made, and strategies employed. Some, such as estate planning, require a competent business valuation where the firm conducting the valuation fully understands the techniques and strategies available to help mitigate estate taxes. Others, such as income taxes, can be mitigated by various structures, and/or through taking advantage of various tax credits and other tools that many business owners are not even aware of. These include hiring credits, enterprise zone credits, research and development credits, training credits, deferred compensation arrangements, defined benefits plans, and others.
Finally, many employee benefits plans, especially ESOPs, can provide significant tax incentives while also providing employee benefits.
The Active Exit Planning Stage: Your Options
When you start to consider your actual exit, it is important to work with an advisor that can explain your options in a clear and concise manner. At the same time, it is important for you to understand the implications of each option, before, during, and after the actual execution of the strategy.
The primary avenues to transfer ownership in your company are to sell/transfer to:
- A private equity group (PEG) or a portfolio company of a PEG;
- A competitor or a strategic buyer, either public or private;
- A key employee or a subset of your management team ;
- The broader group of employees through an Employee Stock Ownership Plan (ESOP);
- Family members (which could also include an outright gift); or,
- A charity.
Some of these strategies can be employed in concert with one another, but all of them come with their own pros and cons. Your advisor should be agnostic as to which strategy they help you employ, and they should educate you on the best strategy to help you achieve your unique goals. In some cases, this will be to sell to the highest bidder, where in other cases, it will be more important to preserve the company culture and reward employees. It may also be to perpetuate the family legacy through an intra-family transfer, or to retain key management by offering equity participation.
No two businesses, nor business owners, are the same, and each of these strategies carry different perks and challenges. What they all share, however, is that in all of these cases, sound, independent, and unbiased advice is critical for success.