Understandably, when someone sets up a new business, the exit strategy is not usually the main focus. Often it’s not even considered.
I think that’s a mistake; every small business owner should have an exit strategy. Here are the major options for you to consider and the reasons you might have for choosing one over another.
1. Family succession
In theory, selling or transferring to a family member should be one of the easiest exit strategies. The founders of the business will be dealing with familiar faces who know the business and are bound together by common history and bloodline. But the reality is that family business succession is often complicated. Never think this is a science, it is all about human behaviour around money which is often irrational.
I strongly believe that family succession is a goal worth striving for, but it’s also something that we could do a lot better in New Zealand. If we get it right, there are real social and economic benefits for our cities and provinces from having a strong family business sector.
2. Management buyout
A management buyout (MBO) involves the management team pooling resources to acquire all or part of the business they manage. Most of the time, the management team takes full control and ownership, using their expertise to grow the business.
An MBO can allow for a smooth transition. If the strategy is set early, then employees who know they have the option to buy out the founder tend to work harder to make a success of the business. An effective MBO can be a relatively low-risk exit strategy with the new owners more likely to bring along the key employees, clients and business partners.
On the other hand, experience suggests that an MBO may be less profitable to a founder who is exiting than, for example, a public listing, trade sale or private equity buyout.
Selling to employees can be done in a few ways. In New Zealand it’s common for a simple sale-and-purchase event to occur at a designated time. Such a transaction often relies on both strategy and opportunity, and is usually financed by a combination of personal investors, banks and the seller.
An MBO can also be phased in by an employee share scheme, which is a plan that allows employees to acquire ownership in a company over time. International experience proves that businesses with employees participating in the equity through a share scheme can be very successful when compared to other ownership models.
When I worked overseas, I observed some employee share schemes being phenomenally successful, to the point where long serving receptionists and facilities managers became instant millionaires following a subsequent liquidity event. I will write further on employee share schemes in a future blog because, like family ownership, I believe there are real economic and social benefits to New Zealand having a strong community-owned business sector.
3. Merger, acquisition or rollup
This is the consolidation of companies or assets through various types of buying and selling. A merger involves the merging of a business with a similar company, while an acquisition simply means a business is bought by a larger company. A rollup is where various independent but similar businesses are consolidated.
Common reasons for a merger, acquisition or rollup include:
Liquidation is a term that is synonymous with failure but in my view it can be a legitimate and effective exit strategy. This is especially so for a small business that depends on a single individual. The reality is that sometimes there isn’t much to sell because the founder essentially owns a job rather than a business. In those cases, liquidation might be the best option.
A benefit to liquidating a business is that it is relatively simple as it usually involves a simple asset sale. On the other hand, asset sales in a liquidation are rarely profitable. There is usually no price to be paid for goodwill, client databases, loyal employees and other intangible assets and second-hand equipment is rarely sold efficiently and at worthwhile prices.
5. Draining it
While it seems counter-intuitive, this is a legitimate option where a small business generates a lot of cash flow without needing much attention or capital from the founder. Similarly, where the business is likely to be disrupted in the short to medium term and would require significant capital expenditure to pivot into a more sustainable business model.
In such situations the founder usually invests nothing into the business and withdraws all or most of the profit over time until there is nothing left of the business.
While it may seem like a cynical exit strategy, it’s a genuine one. This is especially so for some Baby Boomers who don’t have the time, energy or appetite for debt/capital raising to pivot the business and/or whose children have joined the New Zealand diaspora and have no interest in family succession.
I often see great family businesses grappling with exactly this issue and who (sadly) opt for a draining strategy. I wish it were not so but it is not always bad and, if the strategy is set early and employee and creditor interests are properly provided for, then liquidity can be systematically diverted over time from the business into other more sustainable and succession-ready asset classes.
There are of course other exit strategies. I was tempted to include an initial public offering (IPO) in the list, but as a consequence of a gradual decline in our capital markets since the late 1980s, the availability of cheap(ish) credit and the demanding nature of shareholders and financial markets regulators, IPOs are now rare in New Zealand.
As to what strategy is best for the business will depend on a range of factors and circumstances. But, in my view, small business owners and their advisors in New Zealand need to be more strategic rather than solely transaction focused.
A good strategy will lead to a better transaction. The best time to develop an exit strategy was when the business was founded. The second best time is today.
This article first appeared on MYOB in July, click here to read the full article.