Partial Realisation Of Business Value For Owner-managers

If you’re in the fortunate position of having successfully grown your business into a thriving enterprise and are considering your next steps, it may be that you feel like you’ve done your bit and want to exit the business in a completely clean break. However, the reality is that this is a rare scenario.

A buyer will usually want the seller to stick around for a while to lock-in their detailed knowledge of the business and to ensure the best possible transition of customers, suppliers and staff to the new regime. From a seller’s perspective, this kind of overnight switch from owner/manager to employee is often difficult.

It may equally be that you don’t want to go from full time (and then some) owner/manager to full time retired in one fell swoop. The chances are that you are invested in your business on an emotional level as well as financially, and it’s rare for someone to have committed the time and effort needed to build a successful business if they don’t genuinely enjoy the work. So, what if you just want to realise some of your investment and free up some of your time, but aren’t ready to walk away completely? This article sets out the principal options open to you.

Management buyout (MBO)

A management buyout is the acquisition of a company by the management team, supported by external financing. Whilst this often involves the sale of 100% of the company, it is not uncommon for the original shareholder to retain a stake in the business and remain involved. This has a number of potential advantages, including:

• The existing management team know and understand the business, which can make the due diligence process more straightforward. This can also limit the contractual protections the seller needs to give to the management team in the share sale and purchase agreement.
• If the seller remains an active part-owner of the business, any issues which do arise post-completion are more likely to be dealt with collectively by the new shareholders in a collaborative way, which limits the risk of warranty and indemnity claims.
• An MBO avoids the potentially damaging disclosure of sensitive business information to trade competitors and avoids the risk of a transaction with a trade buyer collapsing at an advanced stage after that buyer has had access to sensitive information relating to the business.

However, it is often the case that the external financing available for an MBO is not sufficient to pay the full purchase price for the seller’s shares on completion. In this scenario, the seller will typically need to wait a number of years to be paid out in full, normally out of the future profits of the business. A related point is that a sale to an existing management team potentially misses an opportunity to introduce fresh ideas and skills in order to drive the company forward.

Private equity investment

A private equity investor will typically want to buy a stake in a business to hold for a defined period of time before realising their investment at a profit. They will therefore want to have a clear exit timetable agreed at the outset (whether a trade sale, a stock market flotation or some other route). The private equity investor’s desire to make a healthy return also means that they will want a concrete plan in place to grow the business over the period of their investment. For a partial seller, the advantages of this include:

• The ability to remain involved in the business for a defined period (as opposed to an open-ended commitment), which can work well for someone with an eye on retirement.
• The ability to bring on board new people with different skills and experiences, to drive the business forward.
• Potential access to capital to grow the business or adopt a ‘buy-and-build’ strategy.

However, as always, there are some downsides, including:

• If the investor wants to exit five years down the line – or even sooner – this has the potential to disrupt the business.
• The due diligence process will certainly be tougher than would be the case for an MBO and, in reality, probably tougher than for a trade sale. A seller should therefore expect the sale process to last around six months and take up a significant amount of their time during that period (on top of the day job).
• A private equity investor is likely to be fairly hard-nosed about the scope of the seller’s continued involvement in the business. Such investors will be motivated primarily by the expectation of a return on their investment, so this may not be a workable route for anyone looking for a gentle wind-down to retirement.

Share options

Traditionally, when looking to incentivise employees with share options, companies have tended to issue options to subscribe for new shares. However, this doesn’t have to be the case and it is equally possible for a seller to grant employees options to purchase some of his existing shareholding. (These can include the ever-popular EMI options, with their associated tax advantages.)

Whilst this route doesn’t necessarily address the transition of management responsibilities to the employees, it does represent a potential way for a business owner to realise some of their investment over time, whilst incentivising key employees to remain with the business. Including the achievement of performance goals as conditions precedent to the exercise of the options can also be a powerful management tool.

However, options are, by their nature, exercisable in the future and (particularly if EMI options are used), will generally be exercisable at the market value on the date of grant. For a shareholder wishing to realise some of their investment, the obvious disadvantage is that they may end up agreeing to sell at today’s price, knowing that this won’t be paid until some point in the future (and with no guarantee that the option will ultimately be exercised).

Conclusions

Clearly each of the above routes has its pros and cons and, for anyone considering a partial exit, they will need to carefully consider these in the context of their own goals (both business and personal).

In the absence of a ‘one size fits all’ solution, professional advice should be sought on the legal, commercial and tax implications of any proposed course of action. BHW’s Corporate and Commercial Team have extensive expertise in business and succession planning and would be pleased to discuss your business and succession planning with you.