How to Exit a Company: Exclusive Negotiations vs. Auction Process
As much as every business owner would like to think that his business will last for the longest possible time, it is a sad truth that nothing lasts forever. There is bound to come a time when the business can no longer carry on, or the business owner may no longer be able to run the business.
At the risk of sounding morbid, even when you are drawing up a business plan, it is a good idea also to make plans on how to wrap things up neatly, and to your advantage. In other words, entrepreneurs who are going into business should have an exit strategy in place. This is not being pessimistic; this is called planning ahead and being realistic.
In this article, we will learn about 1) exit strategies, 2) primary exit strategies, and 3) exclusive negotiations vs. an auction process.
An exit strategy is defined as the method by which a business owner intends to get out of an investment he or she has made.
In this context, an exit strategy is simply put, a way to pull your money out of the business.
What is the main reason for having an exit strategy?
- From the point of view of investors, the only time they can see a return on their investment is when they cash out, or when the company has been sold. Of course they would want to collect what is due them; it is, after all, their money that has been invested. Therefore, it is important for the business to plan an exit.
- From the point of view of the owners, the business may have lost its novelty or the challenge has “dulled”. Sure, things were exciting when it was still in its initial stages, and making it grow was a huge part of the fun. However, the owner may find that the fun is no longer there once it has grown so much.
- Having an exit strategy in place will improve the probabilities of success in cashing out, and even ease and speed up the process. Since there is a plan for an exit, it is likely to increase the ultimate valuation of the business.
Having an exit strategy is very important.
PRIMARY EXIT STRATEGIES
- Liquidate the business. To cut the long story short, business operations will shut down, the business will close its doors, and it will liquidate. There are various reasons for this exit strategy, such as major upheavals, a market implosion or crash, or the owners simply want out. This is deemed to be the easiest way out since there are no negotiations involved. Issues, however, could arise among and between shareholders with regards to what will be left to them after the liquidation has been finalized.
- Just take money out. Technically, you will be turning the business into a cash cow. This does not mean, however, that you should milk it dry. This exit strategy only works if the business is thriving, with a steady stream of revenue, in a secure market. Get the cash, pay yourself, pay off the investors, pay someone else to continue running the business for you, and enjoy the money as it comes in. You are still, after all, the owner. Beware of any negative tax implications, however. As you pull money, it may go into your salary, and you will end up paying a higher income or compensation tax.
- Sell the business in an acquisition transaction. In an acquisition, the business is bought out by a larger player in the industry. Bigger companies often prefer purchasing smaller companies because it is a faster way to increase revenues instead of coming up with new product or service offerings on their own. It is also a way to eliminate the competition. The key here to make the most of the exit strategy is to find the right acquirer. From there, you would have to undergo negotiations, particularly on the price and valuation. Of course, this also means that you have to make sure the business will look attractive to potential acquirers.
- Sell the business to a friendly buyer. In this scenario, the buyer is a friendly party, or someone you trust will take care of the business. Ideally, the buyer must have the skills and the know-how that the business owner does not, especially with respect to running the business. Business owners are not averse to this exit strategy since it will allow them to get paid and take some time off while ensuring that the investors also collect their returns. Friendly buyer could be friends, family, or even the employees of the business. The worst possible problem that the business owner can face when applying this exit strategy would have to deal with emotions. If it’s a friend or family buying, it is likely that they will be more forgiving with the valuation. It is also possible that there will be internal conflicts and petty jealousies, which is typical in most family relationships.
- Merge with another company. Merging with a similar company to come up with a new entity is deemed to be a win-win situation, since the two companies are in the same line of business, or within the same industry. Thus, they will benefit from sharing skills and resources.
- Go public. This means you should consider an IPO (initial public offering). Unfortunately, this is no longer the most popular and preferred option these days, after the decline of the IPO rate since 2000, during the bursting of the Internet bubble. It was originally seen as the fastest way to cash in, but now, many are shying away from it, primarily because the risk of incurring liabilities is higher, and the business will eventually have to deal with shareholders that are difficult and demanding. IPO is not for everyone. You need only look at the list of companies in the United States to realize that only a small number is completed annually. In fact, there are only a few that have successfully completed their IPOs. It is complicated, it takes time, and it also requires a considerable amount of investment for it to get off the ground. Transaction costs of an IPO alone can run to the millions, and that is already money better off spent in running the business.
There is also the fact that it is a complex process. There are a lot of hoops to go through, and everything must be done in accordance with the regulations set by the Securities and Exchange Commission.
EXCLUSIVE NEGOTIATIONS VS AUCTION PROCESS
Business owners contemplating an exit strategy often find themselves with another tough decision to make: choosing between a negotiated sale and an auction sale. Let us take a closer look at these two options.
This involves having direct dealings with a single potential buyer or acquirer. There are two key features in exclusive negotiations. As the name implies, it is restricted between the business and the party interested in acquiring the company.
- Confidentiality is guaranteed. Since the talks are limited between the two parties involved, the details are kept between the two of them only. In the same way, should the negotiations fail, the unsavory details can be kept under wraps, so it does not adversely affect future and potential negotiations with other parties.
- It offers more flexibility. Dialogues could lead to more leeway when it comes to deadlines, timelines, and scheduling, as well as other details regarding the sale.
- The business owner will have less leverage when selling. After all, they are dealing with only one interested party or buyer, so there is no competition at all. This could result in the seller not getting a good price with respect to the valuation of the business.
In this case, the business is marketed to multiple parties that may have an interest in acquiring.
- When done properly, the business seller is likely to get the best price and terms.
- Competitive tension among the multiple potential buyers will spur them towards acting quickly to put in a bid or an offer for the business.
- Competition will also ramp up the price so that the seller can expect more cash.
- The process can be quite complicated and tedious, considering how it is done in several stages.
- There is possible collusion among bidders or potential buyers that may undermine the leverage of the seller.
- Information may become free-for-all since there are many bidders that will have access to what is supposed to be confidential information about the business.
So which is the better option between the two?
Although auction sale is said to be the more preferred method of selling a business, it has its downsides that may make business owners hesitate and ultimately decide on going through exclusive negotiations.
The decision on which is the better method will largely depend on what you, as the business owner, want to happen. You will also have to take into account the state of the marketplace that the business is in. There are simply marketplaces that will not allow for exclusive negotiations but will be ideal for auction sales and vice versa.
One basic rule followed by many businesses is that, when there are at least two serious buyers, the best thing to do would be to go for an auction sale instead of undergoing exclusive negotiations.
HOW TO CHOOSE THE BEST EXIT STRATEGY
It is important to choose the best exit strategy in order to generate the best value and terms for the business.
Earlier, we have enumerated several of the primary and most commonly used exit strategies. Choosing the right one among them is another hurdle that must be overcome. Here are some tips that will aid business owners when planning their exit strategy.
- Know your business inside and out, and how you can best present it to interested parties. You do not expect to have a successful exit strategy if there are no takers, do you? As the owner, you are in the best position to present your business in the most favorable light to attract potential buyers, acquirers or other parties that will figure greatly in your planned exit.
- Establish priorities for exit transactions. What is more important? You have to know what you need. The company may place more importance on generating cash to meet its obligations and working capital demands. It could also be that the seller is more concerned about speeding up the whole process so it can be quickly done and over with. In some instances, the primary concern of the seller is to exit with the least tax implication.
- List down your options. What, exactly, are the alternatives open to you? From the many exit strategies available, which one is applicable to your business? Eliminate those that are not applicable to your business; this will considerably narrow things down.
- Compare prices. Which among the options available to you will give you the best price and the best terms? You also have to consider the tax implications to the business, to you, and to the other shareholders if you choose any of the alternatives.
- Compare the costs. Exit strategies will cost you resources. Which one will be more resource-intensive? Which one will cost you more money?
- Compare timelines. How long will the alternatives take you to plan properly for an exit? Will you have enough time to put the business in shape in order to meet the requirements of the strategy that you are considering?
- Consider the risk factors in disposal. Naturally, you are likely to scrap the exit strategy that will pose the most risk to you.
- Get good advice. It is a fact that exit strategies are not all that simple and straightforward. In fact, they are so complex that businesses seek the help and advice of professionals.
At the end of the day, when choosing the exit strategy for your business, make sure that the circumstances of the business and the priorities it has established are aligned with the exit strategy being considered.