Turning Personal Goals And Business Aims Into An Actual Exit Strategy
Have you ever noticed that exit strategies are categorized by type of transaction – an IPO, sale to a strategic buyer, buyout by private equity, sale to an ESOP – but too infrequently broken down by what they accomplish for the owner-founder-entrepreneur?
Mea culpa: in writing this column, I frequently rely on those categories to discuss ownership transition.
But one of my goals as an investment banker – I’ve helped more than 300 company founders sell all or part of their business – is to change that pattern of language, and to get us all talking about practical outcomes that serve the owner, his or her family and the business itself.
I encourage you to ask yourself the following questions, as you and your business mature:
–How do I want my working life to play out in terms of continuing role at the company, and what’s the right balance between work and other activities?
–What are my near-term and long-term personal financial needs and goals?
–This company I’ve built – how would I like its future to play out?
For many a founder, the answers to these questions take years to come together. And only then is it possible to start to devise a strategy that makes sense for the individual and for the business. And quite often, there’s no actual exit, but rather gradual yet significant adjustments in ownership and management role that place a high value on the founder’s vision and contribution, on the continuing growth and success of the business, and on the need to make wealth tied up in the business more liquid and available.
To me, and I’d imagine to you, what form a transaction takes is less important than whether it achieves your goals.
To that end, no matter how busy things are running your business, I implore you to find an estate planning expert you trust and admire. As I reported in this previous estate planning article: good investment bankers can steer you to the right buyer with a superior price, perhaps a 25% increase over mean values. A good estate plan can add upwards of 50% economic value and superior alignment with personal goals for family, estate and charities. Imagine if you did both?
Once you and your estate planner have laid the groundwork, considering and shaping a transaction becomes so much easier. And you’ll be better able to focus on after-tax wealth creation, not just the dollar amount of an offer.
My chosen specialty, the Employee Stock Ownership Plan, or ESOP, for instance, gets a far more receptive hearing from business owners who’ve been through the estate planning process. While surveys that ask about exit strategy in terms of transaction type often find fewer than 10% of owners considering an ESOP, a far larger percentage want to explore the ownership format once they’ve learned the following:
–If you own a C-Corporation, selling to an ESOP can allow you to defer capital gains taxes, potentially forever, by investing in qualifying securities, namely stocks and some bonds. That’s 23.5% or so that doesn’t have to come right off the top.
–If an ESOP-owned company becomes an S-Corporation, it pays no federal income tax; rather, as with 401(k)s and IRAs, the worker-owners pay the tax when they withdraw their shares upon retirement or otherwise leaving the company. That means, rather than paying 35% or so of income in taxes, S-Corporation ESOPs can use their superior cash flow to pay down acquisition debt more rapidly, invest in growth through plant and equipment, or make acquisitions.
–Many owners stay on as CEO and retain a stake through warrants negotiated along with a seller note. That gives the owner a piece of the upside that comes from the ESOP S-Corporation tax benefits.
–Perhaps even more upside comes from a productivity boost employee-owned companies enjoy. Decades of studies have shown that ESOPs outperform similar companies operating under different ownership formats. And a recent study showed, on an investment basis, ESOP companies vastly outperforming the S&P 500.
–ESOPs are compatible with private equity investing. Increasingly, astute private equity funds are investing alongside ESOPs and, when time comes to sell a private equity portfolio company, funds are turning to ESOPs as buyers.
But we’re getting ahead of ourselves. I’m confident that exploring your goals as a business owner will lead you back in this direction.