Do you have an exit strategy?
A decision to bring new capital into your business is a significant one, and contrary to what you might read elsewhere, it is less about the business than what you might think. It is, more to the point, about you, the founder.
It might surprise you to know that most businesses never grow to a point where selling down part or all of a company is possible. While large businesses have the opportunity to sell through public equity markets through public listing, closely held and family owned businesses rarely have that option. Only a small percentage of companies will ever successfully attract fresh capital or be sold. Mostly, this is about the company, but its also about you. Where an owner is too involved in the business for it to transition effectively, where the founder weighs more heavily keeping family involved than seeking the best team to have around them, where the company is too reliant on a small number of products or has a small number of customers, and where the addressable market is too small, new equity is rarely possible without careful preparation.
If you have a business that has grown to a point where the revenue isn’t entirely driven by you, if you have more than 10 employees, are profitable, and are starting to think about your options for bringing in new equity or divesting, congratulations. You have accomplished what most business cannot, and you have options.
Is it time to bring new equity into my company?
Not necessarily. There are of course a range of options for exiting a business in part or in whole, and starting to think about your next phase of life. Firstly, you have the option of outright sale, perhaps through sale of the business to a new entrant, an adjacent industry or a competitor. Secondly, you might choose to sell down through a series of employee share ownership plans (ESOPs) which could see ownership of your business transfer over time to senior employees or leaders in the business. Thirdly, you might encourage a management buy-out, where a group of employees acquire the company from you. Fourthly, you might choose to gift or transfer part of all of the company to the next generation. Lastly, you might choose to recapitalize and invite new capital through venture or growth equity funds, setting the scene for a four to five year acceleration of the company and the opportunity to use outside capital to really see the company achieve its potential.
Deciding which path to take is about you, not the company. There is a big difference between planning for an exit and planning for a sale, with the principal difference between what you want to do. What are your goals for yourself and the business? Do you want to leave now, or in 5 or 10 years time? Would you like some money to re-risk your lifestyle, perhaps paying down home loans and then being able to focus more on the growth of the business? Do you need a partner that can bring new skills and focus to the business, or perhaps governance? Could you see yourself working for your competitor for 2-3 years if they bought your business? Do you feel a responsibility for maintaining your legacy beyond your time at the company? These are all critical matters which define whether the sale or part or all of your business is best for you, and most importantly who your ideal capital partner would be.
A good adviser will start by asking you these questions. They will determine if you are the “sell my business for the highest price so I can retire” founder (which might be best being sold to a competitor or strategic buyer with the least possible tie-ups for the founder) ; the “I need a capital partner to help me unlock growth for the company (which might be best being partly sold to private equity or venture capital) founder; or the “de-risk my lifestyle and help me focus on a period of strong growth” (which could lend itself to private equity with a greater focus on secondary “off the table” investment) founder. These small questions tailor how the adviser approaches the market, and who they contact to find the best partner for you.
Raising capital or selling can be stressful mainly because of mixed perspectives. All business has risk, and for new capital to enter the business, this risk needs to be understood and weighed up by a new buyer. Often, once a business has been listed for sale or an equity raise has begun, founders will react with dismay or anger at the focus that potential investors have on the negatives of the business rather than the upside which the founder feels is just around the corner or which they have been working towards. I often hear founders ask why investors don’t get it, and when they are going to really take the time to see what they see in the business. Part of this reflects a mismatch between the perspective of the founder, who loves the business as a parent might love a child and often ignores what can be significant shortcomings, and the incoming investor which needs to price the risk and put their own money at risk, and can only react to what they see in front of them in accounts, pipeline, performance and customers. For a founder, last years profitability is often less important than what is coming, and culture, values and growth are the main things that keep a founder up at night. An investor wants all of these but also to understand and protect against the likelihood of failure and the loss of their own investors money. Founders need to remember that in the early years they have been like tightrope walkers without a net, and that for new investors a focus on downside is not disrespectful. Patience is key, and like most cross cultural discussions, it is important not to jump to conclusions and to assume motives on either side.
As an example, assume a founder who would like to take a larger amount of the investment as secondary (often called “off the table”) rather than primary (which goes into the company and can be used for growth). This can be a quite natural expectation for the founder, who might want to de-risk his or her lifestyle by paying down their debts and perhaps getting a well earned holiday or a new car. For the private equity investor, this needs to be communicated carefully; PE wants founders happy, but not so happy that they don’t want to work hard to grow their investment in partnership with them towards their exit event. When both sides explain their concerns and their expectations, the right balance can be struck.
For those curious about raising capital or divesting, it is worthwhile distinguishing between a transaction and a strategy, and choosing advisers that understand this. There are four tips that are worthwhile considering”
It is the owners motives and goals that matter, not the advisers. Often a founder will think that advisers should work only for success fees and not retainers – this works for as long as there is a smooth road to close and founders can find themselves without an adviser when the road gets bumpy.
Avoid advisers that are transactional, and not relationship based. When the raise gets hard, it is far better to talk to someone who understands the complexity and the personal nature of why you love your business and what you want for it and for your people.
Avoid a focus solely on valuation or price. We always tell our clients that the partnership matters more than the price. Particularly where private equity is concerned, this is a marriage not a trade, and there will be multiple liquidity events. In our experience, most PE firms will value a company within 10-15% of each other as most use multiples of EBIT or revenue, either on the last 12 months (LTM) or next 12 months (NTM) where revenue has been booked.
Be patient and be curious about the process and the way you feel. Inviting equity into your business is as much of a change for you as it is the business and your team. You will feel different emotions as the journey continues; misunderstood, elated, stressed, overwhelmed, fatigued and then finally motivated and driven with the validation that having a great partner provides.
Keen to understand more? Message the team and lets continue the conversation.