Cashing out in a constructive way

After you’ve worked hard on building your business from the ground up, it’s understandable that at some point you’ll want to move on and be rewarded for your efforts – but how do you ensure you get most bang for your buck?

Common reasons for builders wanting to sell their businesses include the desire for a lifestyle change, taking the opportunity to begin another venture, accessing the equity they’ve built up over time or simply wanting a rest. Whatever your reason, you’ll want your exit to be profitable and with as few problems as possible.

This month, we look at three common ways a business can be exited and introduce you to a fourth way newly introduced into NZ.

1) Sell to another company

Selling to a large company or a corporate offers up less risk the sale will fall through.

It’s a fair enough arrangement and, in many cases, achieves a good result.Often an amount is paid on signing, followed by a second amount subject to an ‘earn out’ arrangement. This second amount will only be paid if certain agreed financial targets are met and requires the previous owner to continue to work in the business through a transition period.

But there can be some fishhooks to avoid, including:

• Losing control of the chequebook – expenditures you would have made in the past will now have to be approved. If the person approving doesn’t understand your company and the people involved, your spending decisions may be vetoed or delayed and opportunities to achieve your target lost. 
• Having your advice ignored – if your advice is not accepted, then it can be even harder to ensure that the company reaches the target. In the worst case, an ambitious corporate manager may even act contrary to your advice until after you have exited. Then, once you have departed, apply your ideas and gain all the accolades!
• Not benefiting from future earnings – the purchase price of your company is usually calculated on past performance rather than on future earnings. Yet the best years may be ahead, especially if the buyer brings additional resources. If you believe your best years are ahead, make sure you negotiate an additional amount for exceeding target.

2) Sell to another person

You list with a business broker, find a suitable buyer, negotiate a price and the sale takes place – usually with an ‘earn out’ arrangement. Fishhooks to avoid with this method include:

• Your customers may not like the new owner – it’s likely you have kept the possible sale of your company confidential, so your customers don’t get the jitters. Now, imagine if your customers decide not to continue to do business with the new owner – how will the company fund the ‘earn out’ if your customer base evaporates? Consider retaining veto over changes that may affect customer relationships until you are fully paid out.
• No benefit from exceeding the target – if the new owner brings new ideas and the company earns way more than expected during the ‘earn out’ period, the new owner is happy, but you may feel cheated given that you contributed to the additional earnings. Ensure that the agreed ‘earn out’ amount includes a bonus should the company perform above expectations. Also, make sure that the new owner can’t hold back on any sales until after the ‘earn out’ date is past. 

3) Sell to an employee

Maybe you have an employee who has asked about taking a shareholding.

Certainly many small business owners have exited their business by gradually selling off shares to an existing staff member.

It sounds like a smooth transition and is a great arrangement for your customers. As far as they are concerned, it’s business as usual.

Many small business owners have exited their businesses successfully in this manner.

However, even here there are fishhooks to look out for:

• You lose control before you have all your money out. Once you have transferred more than half your shares, you no longer have full control of your company and no guarantee of the business’s ability to pay you the balance of the purchase price. Should the business decline (and the value of your shares with it) then you may be left with less than you hoped for. Before you become a minor shareholder, ensure your purchaser has the ability to complete the sale. 
• Dividends – should you sell a majority of shares, then you will want your remaining shares to continue to yield dividends. However, the new owner determines what the dividend is and may reinvest or increase fixed expenses, reducing the amount to be paid. If it’s your intention to retain shares and gain annual dividends, then you need a rock-solid agreement to ensure they’re protected. 

4) A new alternative – sell to an agglomerated publicly listed company

An agglomeration is a group of SMEs collected into an industry-specific, publicly listed global company.

In an agglomeration ‘sale’, you trade your company shares for shares in a global publicly listed industry specific company (PLC) – made up of dozens of small businesses spread around the world – all engaged in various parts of that industry. You remain as CEO (for as long as you wish) and your company retains its identity, but benefits from all the resources a PLC can bring.

For example, you connect with some of the brightest entrepreneurs in the industry and get help to improve your business.

Further, you get access to larger clients not accessible to small businesses and opportunities to expand your business by strategic purchases. You also have the opportunity to release your capital as and when you need it.

However, while an agglomeration sale avoids many of the normal fishhooks and is likely to achieve a better sale price more quickly, it’s a new take on the traditional corporate sale and does not have a long history. It’s worth keeping an eye on this as it takes hold in NZ. You can learn more at www.agglomeratebiz.com

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Graeme Owen, based in Auckland, is a builders’ business coach. Since 2006, he has helped builders throughout New Zealand get off the tools, make decent money, and free up time for family, fishing, and enjoying sports. www.thesuccessfulbuilder.com