At a certain point in the life cycle of a privately held company the owner usually make a series of decisions relating to the distribution of the accumulated value of the company. Effective planning and knowledge of the alternatives available to the owner can generate superior outcomes in this process. An exit strategy extends well beyond the analysis of tax and estate issues. It also needs to take into consideration the options and alternatives available in light of the owner’s financial and personal objectives and the company’s strategic profile. These objectives must be weighed against the sometimes harsh reality of the capital markets to identify the alternative that best meets the owner’s objectives.
For a private owner considering an “exit”, the objective is to find the right transaction structure that permits the owner to cash out in the near term or over a 2-5 year period. In simpler terms, the question can be condensed to this - How much of the company should I convert to cash now and what is the best way to do that? This question can best be answered by completing the following four steps to successful transition planning:
- Define owner objectives
- Identify the best buyer types
- Define and evaluate alternatives
- Develop a comprehensive sale plan
Step 1 – Defining Owner Objectives
The private owner must answer several personal questions to evaluate the options available to them:
- What is my desired role in the company over the next five years?
- What is my personal risk assessment relative to maximizing cash now and the risks and rewards of building the business over the next 5 years?
- Do I desire to transition ownership of the company to family members or to the management team that is in place?
- What is the level of cash I need out of the company to meet tax obligations and to fund retirement, charitable, and estate goals?
The owner’s objectives establish the basic framework for evaluating a transition and these can lead to a number of strategies that can be radically different. A sale of 100% of a company is a very different transaction from one with a partial cash out and sale to a family member or the management team. Setting up a mechanism to distribute cash to get some chips off the table is very different from raising capital to fund an aggressive acquisition program to build the company and to prepare for a sale in 5-7 years. Other factors that can influence the transition transaction strategy include the owner’s desired retirement portfolio (no retained interest vs partial retained interest) and a realistic market valuation of the company, which could greatly influence the timing of a sale.