Section 15: Exit options analysis

Question 1

What are the two general categories for private ownership transition?

Answer 1

Inside and outside

Question 2

Define the inside ownership transition options?

Answer 2

“Inside” 4

1. Inter-generational transfer
2. Management buyout
3. Sale to existing partners
4. Sale to employees

Question 3

Define the outside ownership transition options?

Answer 3

“Outside” 3

1. Sale to third party
2. Recapitalization
3. Orderly liquidation

Question 4

What are the pros and cons of Inter-Generational Transfer?

Answer 4

Pros
◦ Business Legacy Preservation
◦ Planned
◦ Lower Cost
◦ More Control
◦ Less Disruption
◦ High Buyer/Seller Motivation
Cons
◦ Family Dynamics
◦ Illiquid Buyers/Lack Funds
◦ Lower Sale Price
◦ Key Employee Flight Risk
◦ Tradition May Outstrip Good Strategy
◦ Path of Least Resistance – but not always a path to
growth or success

Question 5

What are the pros and cons of Management Buy Out (MBO)

Answer 5

Pros
◦ Continuity
◦ Highly Motivated Buyers (Pent-up Desire)
◦ Preserves Key Human Capital / Knowledge
◦ Planned
◦ Can be combined with Private Equity to access additional capital and resources for growth
Cons
◦ Management “sand-bagging”
◦ Distraction
◦ Threat of Flight (Coercion of Owner)
◦ Illiquid buyers
◦ Lower price and unattractive deal terms for seller
◦ Heavy seller financing introduces risk
◦ Managers are not always good entrepreneurs

Question 6

What are the pros and cons of Sale to Existing Partners

Answer 6

Pro
◦ Less disruptive
◦ Planned
◦ Well-informed buyers
◦ Controlled process
               - if Buy-Sell Agreement in place and funded
◦ Lower cost
Con
◦ Lower sales price
◦ Potential discord
◦ Competency Gaps?
◦ Buy/Sell may restrict selling options
◦ Realization of proceeds from sale is often slower (and less)

Question 7

What are the pros and cons of Selling to your Employees (ESOP)

Answer 7

Pro
◦ Business stays in the “extended family”
◦ Shares purchased with pretax dollars by the ESOP
◦ Taxable gain on the shares sold to the ESOP by the owner may sometimes be deferred
◦ ESOP is an employee benefit
◦ May cause employees to think and act like owners
Con
◦ Complicated and expensive
◦ Requires securities registration exemption
◦ Company compelled to buy-back shares from departing employees
◦ Generally suitable only for gradual exit over time

Question 8

What are the pros and cons of Selling to a Third Party

Answer 8

Pro
◦ Higher price (highest of the options)
◦ More cash up front
◦ Walk away faster
◦ Stability of deal terms
◦ Business refresh (growth, new energy)
◦ Cost-effective
◦ Breaks deadlock @ management level with family
Con
◦ Long process (9-12 months)
◦ Distraction / Loss of focus
◦ Privacy concerns
◦ Emotional for owner
◦ After sale tie-downs
◦ Highest absolute cost of options (but higher benefit)
◦ Complex – involves about 1000 professional hours
◦ Can be difficult to close

Question 9

What are the pros and cons of Recapitalization / Refinance?

Answer 9

Pro
◦ Allows partial exit
◦ Reduces owner risk
          - diversifies asset concentration
◦ Provides growth capital
◦ Second bite at the apple
◦ Works well with other Exit Options
Con
◦ Continuing accountability to partners (not a clean break)
◦ Loss of control
◦ Culture shift
◦ Slow transaction
◦ Expensive relative to benefit

Question 10

What are the pros and cons of Orderly Liquidation

Answer 10

Pro
o Good option when Asset Value exceeds Value of Going Concern
o Sum of the parts are greater than the whole (asset division produces value)
o Efficient way to exit
o May be less expensive than some of the other options
Con
o Uncertain proceeds
            o No guarantee
o No $ for goodwill
o Emotional
o Stigma?
o Hard to predict costs
o Damage to employees/jobs
o Higher tax (C-corporations)

Question 11

The Readiness Calculus

Answer 11

Triangle
Readiness = options
Successful transition = wealth
Options = Higher probability of successful transition