Options for the future: Part 3

If you’ve followed our last two articles, chances are you’re surprised by your many exit opportunities.

Entrepreneurs often believe they can either stay 100 percent at the helm or sell. Fortunately, this is not the case. Successful owners can capitalize on numerous directions.

In Part 1, we introduced the seven primary options for continuation or exit. These are:

• Do nothing
• 100% sale to a strategic
• 100% sale to private equity
• Majority sale
• Minority sale
• 50/50 sale
• Recapitalization

Having discussed options 1-4, we’ll now review 5-7. We’ll articulate some of the issues and obstacles to make these more meaningful and give you a better vision of what these particular directions may hold. If you’ve missed the previous articles, you can find them here (Part 1) and here (Part 2).

Let’s take a look:

Minority sale – A minority sale is a transaction where you raise money by selling less than 50 percent stake in your enterprise. Minority interest can range from fractions of a percent on up. The larger the stake sold, the more impact minority investors can have on the business’s future.

Control: With a minority sale, operational and financial control typically remains with the majority owner. However, this could change based on the agreement and established voting structure. It’s important to understand that under this direction, even though you still own most of the company, you are no longer completely in charge. This can be a big functional as well as emotional adjustment.

Value realization: Since you aren’t making a 100 percent deal, your value realization will reflect the percentage sold. Additionally, EBITDA multiples paid are typically at least one turn lower because investors don’t get full control. Certain provisions integrated into the sale contract (i.e. how future CAPEX decisions will be made, exit timing) will determine final multiple.

Future growth and participation: Because you still own a majority stake, future growth and participation are largely still under your control. Still, if you’ve selected investors with strategic knowledge (instead of those with just cash), you can leverage their perspectives on strategic direction. The collective intelligence can be a boon for growth.

Owner(s)’ objectives: When choosing a minority sale, make sure it’s about raising new capital for future investment or protecting against pending influences. If you’re simply looking to ‘slow down’ – and still be the chief – your new relationship can sour quickly. It’s important that you have a good handle on your future commitment before making a deal.

Maximizing buyer interest: The ‘limited control’ aspect often makes this arrangement less attractive to potential investors. The pool of candidates usually has very specific motivations and expectations for the majority owner. It’s up to you and your advisors to find minority investors who best match your situation.

Risk: With a partial sale, you can take some money off the table and diversify your investment mix. However, any issues facing the business – good or bad – don’t change. You’ll face virtually the same risk.

Impact on employees: This should be minimal since the same people will run the company.

Timing: By executing this option, you take advantage of the current strong investor interest for labels without giving up its future upside.

50/50 sale – In a 50/50 sale, the two parties are similarly vested. You truly end up with a partnership of equals.

Control: Control can be tricky when parties are equal. Both must agree on key issues and work together. Thus, you need to determine how you will lead and manage day-to-day business, while ensuring the company image isn’t affected.

Value realization: Depending on deal terms, you should be able to achieve an EBITDA multiple close to a majority sale, at half of the value of the business.

Future growth and participation: You’ll need to spell this out at closing. Your contract can stipulate how leadership is split, i.e., whether you’ll act as operating CEO (handle day-to-day decisions) or have an advisory role.

Owner(s)’ objectives: This option is probably one of the best for those looking to take out a sizable portion of their value while still remaining on board and vested.

Maximizing buyer interest: Buyer interest will be higher than that of a minority sale, but not as high as a total or majority ownership transfer. Plus, a private equity deal (PE) deal may not be possible, as their arrangements typically require gaining a controlling interest.

Risk: You’re still on the hook for half the risk. However, the cash provided at sale may support long-term stability.

Impact on employees: If you remain as CEO, effect on employees should be minimal. If the new partner assumes that role, this may change. Understanding the buyer’s vision for your workforce is critical to ensure you’re in agreement.

Timing: Current market dynamics are opportune for achieving an attractive reward.

Recapitalization – Not a ‘sale’, recapitalization involves changing a company’s capital structure. The arrangement may be used to buy out a partner or pay off prior debt obligations. Typically, it involves taking on significant new debt via private placement, traditional bank or mezzanine financing, or a combination of these.

Control: While you still run the business, you now must comply with a check-and-balance system. Terms can include maintaining certain EBITDA targets and leverage ratios, as well as meeting certain schedules for interest and debt repayment.

Value realization: Net value from this strategy will be lower than in other scenarios. You can secure funding only off the assets lenders allow you to leverage.

Future growth and participation: What you accomplish remains up to you. While you will have a financial partner, they will not manage day-to-day decisions. That said, lenders do implement controls that can limit your plans.

Owner(s)’ objectives: This option can be a great way to achieve partial liquidity or gain growth financing. It’s important not to put up any personal assets as collateral.

Maximizing buyer interest: This is a non-issue. You aren’t selling; you’re bringing on new finances to fund growth or provide liquidity.

Risk: Your lenders will be your friends as long as you live up to the provisions of the initial agreement. If not, they may reopen the deal and rework the structure.

Impact on employees: If the company’s cash flow can support the new debt, impact on staff is minimal.

Timing: Lenders’ current strong belief in our industry will support favorable terms.

With your new knowledge of the seven exit options – and their various implications – you have plenty to think about. As you decide on your trajectory, apply these considerations to your unique situation to understand what might be best for you. The label industry’s continued strong performance makes today a great time to do a deal. But be cautious. You sell your company only once. Surround yourself with great staff, great management, great partners, and great advisors. Their support will be critical in ensuring the maximum value for your great business.