How to exit your business successfully

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When considering your exit strategy, do you rely on on a well formulated Strategic Plan or simple Blind Hope? I sat down with a client the other day to discuss the terms of his will. He had just set up a trust to ensure his young son is provided for should anything happen to my client and his wife. I then asked my client what he planned to do with the shares in his two companies, given that his son won’t be ready to take over them for at least 15 years. I was very impressed to discover that he had already turned his mind toward his exit strategies from both companies. All too often we see clients who have not planned or prepared any exit strategy other than to sell the business when they want to retire. Unfortunately, reality is not that simple. Careful planning and preparation is vital to ensure the best price for your business and a smooth transition for both you and the new owner. My client had a fairly
specific plan in mind, which I have summarised below. It raised several key issues which I believe many business owners need to consider over the next few years in order to successfully implement an exit strategy. Recent estimations state that more than 60% of business owners (both in New Zealand and in Australia) are over 50 and 23% over 60. 45% want to retire in the next five years, but very few (around 10%) have a formal exit strategy. The general consensus amongst professionals is that the Global Financial Crisis (“GFC”) has hit the “mid-market” in New Zealand (businesses worth between $1 m to $20m) the hardest. There are currently few cash buyers for these businesses.

Adding to this are tighter constraints on bank debt that mean many deals are now too large for individuals to get involved. If you groom your business well, you may attract potential purchasers and maximise the value of your business. Getting early advice from the right advisors is key and we can certainly help you with this. However if the right purchaser does not come along, you may see your business’ value erode, “leaving retirement/sale plans in tatters, while competitors pick over the carcass for customers, assets and key people” (according to ANZ’s recent Privately Owned Business Barometer).

Don’t like the sound of that? What are your other options? You may want to consider selling to another business in the same industry. We are advised by several business brokers that while this option has been successful in the past, most trade buyers are now too focused on their own economic struggles to worry about growth through acquisition. This attitude is unfortunately short-sighted, but reflects the reality of the GFC. So now you’re faced with a lack of buyers and an oversupply of businesses over the next five years. The situation is even worse if something happens to a business owner that means they can no longer work in the business (it happens, just ask my boss – he had a heart attack the day before I started).

STAGGERED BUY OUTS

If you intend to exit your business in the next five years, and can’t find a suitable buyer, you may be left with one main option – the staggered buy-out. The staggered buy-out can take one of three forms: Vendor finance for a large portion of your ideal price. Les Allen of our office takes a closer look at this option in this article. Third party private equity investment. The writer will consider this option in an upcoming article. Management or key person buy-out. I will focus the rest of this article on this third solution. To implement this, you’ll need to find (and groom) your replacement and conduct a phased exit over time. There are plenty of enthusiastic, ambitious and talented individuals who are the natural successors to New Zealand businesses. The right person may already be employed by you or they may be managing your competitor’s business. Unfortunately these owners-in-waiting often do not have the capital to satisfy your price expectations. That was the situation my client faced. He had found two of these individuals within his businesses and had agreed in principle to a staggered buy-in to each of his companies. This is a form of management buy-out or “MBO”. This option could solve your problems and ensure your legacy, and the jobs of employees, are protected. The MBO or staggered buy-in solves other problems along the way. It allows someone with the right skills to get started on the path to full ownership. Because of the deferred nature of the payments, it allows you to get a better price than you would perhaps get for a cash sale in the current climate. It also allows for a smooth transition as the outgoing owner passes down the knowledge. It even deals with the old problem of “hero to zero”, allowing you as an owner to get used to giving up on being the boss. One of the key things you can do to achieve a good price and smooth the transition. is to make yourself expendable. These deals are clearly more complicated than a straight cash transaction. In addition to an initial purchase agreement, an option agreement (for shares in your company) and a shareholder agreement will also be required. The relationship between buyer and seller is also crucial as you could be in business together for several years. Trust will be required on both sides.

There are several technical issues to be addressed at each stage. These include: Step 1 -Profit share. We recommend that this simply be part of the employee’s salary package, with clearly defined KPls. You will need to address their employment agreement and should consider a management agreement. Step 2 -share sale, new share issue or joint venture? If a share transaction, how many shares and what implications are there for this? (eg. loss of imputation credits) Will they be voting or non-voting shares? At this point, a shareholders agreement (or joint venture agreement) will be necessary, together with a purchase agreement or option agreement and a buy/sell agreement. What is the current value of the shares/business at the time of issue, exercise of option or sale? How will they pay for their share in the business? If shares are issued, will those be considered part of the employee’s salary package, or require a separate investment on their part? A reality check will be needed here, as a complete buyout will depend on the capital resources and ability of your employee to finance the final purchase. You do not want to get into partnership with someone who may be willing, but isn’t able to go the whole way. If you intend to finance them into the share package, what will the terms of that finance be? Will they be entitled to dividends before their shares are fully paid for? Will they be entitled to appoint directors? As managing director, while you can delegate authority, you cannot delegate responsibility. That will also have effect on your leasing, franchising and finance arrangements. We recommend that you discuss with us the terms of each agreement at each stage throughout the process. ANZ estimates as many as 10,000 businesses may need to change hands in the next five years. If even a fraction of that estimate turns out to be correct, only the most prepared owners will achieve an exit at all. We trust that this article proves to be a useful tool in managing a successful, smooth and profitable exit from your business.

If you have any questions, simply wish to discuss any of these matters further, or if you would like some further options for exiting your business, please do not hesitate to contact Andrew Simpson or Les
Allen.

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Les Allen
Partner

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