In the first of our series on exiting, we examine what makes the right conditions for the right exit, taking a first look at the four most common routes; trade sale, PE sale, refinancing and flotation.

Selling a business ranks as one of the most important decisions a business owner will ever make – both professionally and personally. After all, it’s very possible that your business represents a lifetime’s work and most of, if not all, your wealth. For this reason, taking the ‘personal’ out of selling a business is no easy feat. For even the most seasoned of entrepreneurs, exiting can be a highly charged, emotional event. Add to that the potential time period involved – which can be anything from six months to several years – and it becomes clear that finding the right exit route for a business is essential. You simply can’t afford to get it wrong.

Selling a business is not like selling a house. You can’t put it for sale to ‘test the market’. If a business is placed on the market and withdrawn several times, it can gain a reputation for being permanently for sale, which will make it less desirable to future bidders. That’s not to say you can’t – or shouldn’t – withdraw your business once it’s gone on the market of course. Just that making the decision to put it on the market isn’t one to be taken likely, and should only be made if there’s a high probability of success.

REASONS TO EXIT

There are many reasons why you may want to exit your company (and usually more than one), but for most business owners, it’s a question of realising capital. Common reasons for exiting include:

• Your business has peaked or can’t grow without further capital
• Your business needs to access new markets by being part of a larger or international group
• Your business has outgrown you, so you’re unable or unwilling to manage it
• You’re approaching retirement
• There’s been significant discord among shareholders
• Financial constraints mean the alternatives are closure or receivership
• You’ve been approached by a credible buyer/buyers

While the above reasons pertain to the business in question, there’s likely to be external factors affecting your decision too. For example:

• The state of the economy
• A market bubble – resulting in a high valuation or the risk of a downturn
• The acquisition or merger strategies of major players in your sector
• Important changes in technology or market conditions
• New legislation or regulation that directly affects your business
• The arrival – or possibility of – a strong competitor entering the market
• The strength of the M&A market and the stock market

CHOOSING YOUR EXIT ROUTE

Once you’ve made the decision to sell your business, the next step is choosing your exit strategy. The four main routes to exit involve one of the following:

• a trade sale
• a full or partial sale to a private equity firm, family office or HNWI
• a refinancing by taking on debt
• a flotation/initial public offering (IPO)

As you might expect, each option has very different implications regarding how much cash you can realise, and how involved you’ll need to be with the business once you’ve sold it.

Trade sale

A trade sale is simply the sale of one business to another, often a competitor. If you’re looking for a 100% cash-out, a trade sale is your best bet. It can also be the most straight-forward way to exit your business as the due diligence process is typically lighter for trade sales than with PE/family office/HNWI sales.

However, if your business remains reliant on you at the time of sale, the buyer may insist on an earn-out structure that forces you and/or key management to run the business for a period of time after the sale – and you won’t receive the full cash-out until after this period finishes. (You can reduce the chance of this happening by devolving management responsibilities before the sale.)

It’s also worth noting that a trade sale will typically offer less equity upside to the management team. However, in some cases (such as the sale of Marsh & Parsons to LSL) deals have been structured like a private equity transaction so management can profit from further equity upside.

Private Equity Transaction

If you want to de-risk your finances by taking some money out, but still want to expand your business and keep a share, selling to a private equity firm could be your best option. This is because unlike trade sales, a private equity transaction usually involves a partial sale with owners typically asked to reinvest a proportion of their sale proceeds into the acquiring company. Assuming your business benefits from the PE investment and grows, your residual shareholding could significantly increase by the time you come to sell again.

If it’s a clean exit you’re after (or at least one that involves minimal reinvestment), you’ll need to replace the management team with a new one that’s performed well for at least 12 months prior to selling.

NB: The above principles apply if you sell to an HNWI or family office.

Refinancing

There are several ways to refinance for an exit but, typically, refinancing with bank debt involves taking on debt that’s supported by your company’s profit stream, before distributing the loan to shareholders by means of a share buy-back. The shareholders will need to look into the issues involved in making a refinancing tax effective.

To cash-out of the business completely, your company would need to increase in value enough to enable you to withdraw the equity in your business in exchange for a higher loan amount. This gives you access to the value of your business without you having to sell it.

If you choose this option, remember that interest rate environments are cyclical and will impact your loan terms. The Bank of England’s monetary policy, current economic cycle, and market competition will all be key factors causing interest rates to increase or decrease for consumers and businesses.

Flotation/IPO

If the market’s right and the value of your business exceeds £50m, going public could be the most profitable route to exit. It’s also a great way to combine an exit with raising new funds for the business, or to provide an acquisition currency.

However, it’s worth noting that lock-in restrictions preventing you from selling your shares for a period after listing will stop you cashing out immediately. What’s more, unless your company has a very large market capitalisation (i.e. around £200m or above), the lack of liquidity in the company’s shares will restrict your ability to sell your shares in the future. Remember that your business will be subject to heavy public scrutiny too, but that you’ll also have the chance to reward staff and increase your business profile in a way that’s transparent and open.

Overall, an IPO is a realistic option if your business is large enough, and can be an ideal way of achieving a partial exit with further realisations at a higher value. For these reasons, an IPO is only a realistic option in a limited number of cases – but when it is realistic, it can be the perfect exit mechanism.

Cavendish has released a book called ‘Definitive Guide to Selling Your Business’ – to order a copy please see here