How Do I Sell Thee? Let Me Count the Ways

It’s been said that the best time to plant a tree is 20 years ago — or today. The same applies to your business; the best time to plan the sale is the day you start the business — or today. Deep down, every owner realizes someday she or he will exit the business. The question is, on whose terms will you exit?  The U.S. is in the midst of the largest generational wealth transfer in the history of the world as baby boomers retire, sell their businesses, and leave inheritances to their children. A January 2017 headline in The Washington Post read, “A Record Number of Small Business Owners are Selling Their Companies”. I would have expanded that headline to explain, “Putting Downward Pricing Pressure on Exiting Owners who have not Properly Planned”.

The majority of business owners for whom I provide exit planning services start their businesses while following an opportunity or passion. They keep their heads down, working hard for years. One day, they look up and survey the business they have created without any idea of what comes next. Many feel there are only two options: sell 100 percent of the business or, in the event there is no family member to carry the torch, continue to work until they are dragged out feet first. Between those two extremes, there are an infinite number of exit options to explore. Let’s examine just one option for a hypothetical business owner, Will.

Will is 64 years old and began a metal fabrication business, MetalCon, 20 years ago. He has a passion for the industry, his company, and he cares deeply for his employees, but he has no children and has not groomed an internal successor. Will has a great reputation in the industry, and while MetalCon is still growing, he feels that if he were younger and not so risk averse, additional capital could help his business grow even faster organically. Furthermore, that capital could allow him to acquire some of his competitors who are struggling with their exits. He would like to slow down, but feels that selling now would be premature since there is still solid growth on the horizon. He is troubled by the situation, and constantly asks himself, “How do I maximize the value of my business without the energy or capital to execute on the opportunity?”

If he wanted to sell 100 percent of his business and didn’t care how his employees were treated after his exit, then he would look for the most money. Will, however, would be better served by finding the best money. A leveraged buyout with a private equity firm or individual with industry expertise could be the perfect play. If structured properly, it could allow him to remove the vast majority of his chips from the table while allowing a mechanism for his key employees to benefit from the increased value of the company. Will would continue to own a significant equity position while someone with deep industry experience, substantial skin in the game, and access to capital takes his business to the next level.  

Here’s how it might work: Will’s advisors locate a private equity group (PEG, LLC) with experience in fabrication, looking to take a majority control position in a business like MetalCon and place top management talent to run the business. MetalCon generates $3 million annually in EBITDA (Earnings Before Interest, Tax, Depreciation, and Amortization), and the negotiations have set the entity value at $18 million. From there, PEG organizes a strategy for capital:

• PEG finds a senior lender to loan MetalCon $5 million dollars while giving a security interest in fixed assets and accounts receivable.
• PEG finds a mezzanine lender willing to loan an additional $6 million in subordinated debt.
• PEG puts $4 million of equity in the deal. 
• All new money goes to Will in a partial redemption of his interest.

Each of the above steps changes the enterprise value as well as Will’s personal economic situation.  Here’s how the math works:

• The pre-acquisition enterprise value is $18 million.
• Will receives $5 million from the senior loan which drives the enterprise value down to $13 million due to the $5 million of new debt.
• Will receives $6 million from the mezzanine loan which drives the enterprise value down to $7 million due to the $6 million of new debt.
• Will receives $4 million from the equity infusion which has no net impact on enterprise value since the $4 million went in and out as equity.
• The original enterprise value was $18 million and Will has received $15 million, more than 83 percent of the enterprise value in cash while not being a guarantor on any of the debt.

The enterprise value is now $7 million. Will still owns $3 million of equity, and PEG owns $4 million of equity. Will retains 43 percent ownership in the new entity while cashing out more than 83 percent of the negotiated enterprise value. He offers 3 percent of his 43 percent to key employees as a thank you.

Make no mistake, there is still risk on Will’s $3 million of equity, but he can rest easier knowing that an outstanding management team has a huge investment in MetalCon.  By focusing on finding the best money, Will is in a unique position to ride the coattails of an organization with deep pockets looking for growth by leveraging his contacts. This plan seems like a great solution, but there’s still icing to put on the cake: Eight years from now, PEG will exit MetalCon for $35 million, giving Will a second bite of the apple, which is significantly larger than his first.