Structuring a business exit – what are my options?
By Harry Walker – Partner, FRP Corporate Finance
There are many ways to sell a business – but not every approach will deliver the same benefits for every shareholder, company or circumstance.
Taking the time to weigh up your options is a critical part of succession and exit planning. Here, we explore a number of exit paths that shareholders can take – and their respective advantages, and considerations.
Sale to a trade or private equity buyer
A traditional exit route is selling the company to a third party – either a private equity house, or a trade buyer.
As I explored in my recent article on the relative merits of trade vs. private equity sales, each can help meet different objectives – trade sales often give the opportunity for a full exit now, while private equity offers a potentially larger exit in a few years’ time, albeit with higher risk.
Deciding which option to pursue will therefore very much depend on a shareholder’s life plans. But certain factors about the nature of the business can help make it more appealing to a trade or a private equity purchaser, respectively – and this will also influence the decision.
On an operational level, trade buyers and private equity investors share many of the same considerations. They fundamentally want to see a good quality product or service offering, preferably with a defined niche and a defensible market position; an established business plan; realistic financial projections, and detail on past financial performance.
But they differ on some points – points that shareholders may be able to emphasise to their advantage to maximise interest and valuations.
Private equity buyers ultimately have their eye on their own exit – they will eventually be looking to sell to realise their return. Because they are purely financial investors, not business operators, they’ll be drawn to dedicated, capable and incentivised management teams, who they can trust to keep the core business on a good path.
By contrast, trade buyers may be more forgiving of an incomplete management team or missing ‘key individuals’, as they can draw from their own teams to plug the gaps.
Similarly, private equity buyers will be particularly drawn to cash-generative businesses, and will be especially interested in evidence of healthy financial projections.
For trade parties, however, growth, revenue and profit might not be everything. They may see the acquisition of a business as giving them advantages in terms of operational synergies, or new cross-selling opportunities, and price these in accordingly.
For anyone looking to sell a business to an external third party, it’s essential to understand what the strengths of the business are, what buyers will be looking for and how to get the presentation of the relevant factors right. The support of a Corporate Finance adviser can be invaluable.
Vendor-initiated buy-outs (VIMBOs)
Another exit option is a vendor-initiated management buy-out (VIMBO).
Here, the business is sold to the management team. However, rather than the management team or a private equity buyer approaching the shareholders – as would happen in a management buy-out – a VIMBO involves the shareholders coming to the management team with a proposal to assist them to buy the company. This is often a structure we see used for succession between generations in a family-owned firm.
VIMBOs have a number of advantages. Firstly, they put the shareholders in the deal’s driving seat – giving them control of the timing, and the proposed structure, as well as not taking the business to market with third parties.
In contrast to an MBO, which is usually funded by a third-party, a VIMBO is likely to involve the vendor funding the deal through capital or future value from the company itself – for example, through loan notes or preference shares. This means it can often proceed in cases where there may not be third-party interest in plugging the gap between price and available debt funding.
Like with an MBO, selling to the management team can help protect a business’ existing culture. The deals themselves can often be structured to allow the shareholders to remain in the business for a transitional period with an equity stake – allowing those that seek a more transitional exit the opportunity to retain a say in how the business is run while maximising the value they can take from the company. And gains realised from a VIMBO can qualify for Business Asset Disposal Relief (BADR) – providing a particularly tax-efficient exit option.
However, a VIMBO may mean that shareholders don’t realise as much value from their business up-front as they could do through a trade or private equity sale, assuming those options were also suitable for the company.
Often, value will be released over a longer period of time, and shareholders looking for a clean exit may find it harder to step away entirely while this is ongoing.
Employee-ownership trusts (EOTs)
A sale to an employee ownership trust (EOT) involves shareholders selling a controlling stake in the business to a Trust that holds shares for the benefit of all eligible employees.
Trustees are appointed to act in the best interest of the business’ beneficiaries – the employees of the underlying business.
When EOTs were first introduced, the majority of shareholders of owner-managed businesses tended to find more traditional routes of sale – such as selling to a trade buyer – more desirable. This was largely due to the 10 per cent CGT rate that applied to gains of up to £10m, which qualified for BADR (known at the time as Entrepreneurs’ Relief), alongside the fundamental ‘unknown’ of what selling to an EOT meant.
Today, EOTs are far more common – in part due to greater awareness of them, a number of successful, high-profile examples, and curtailment of BADR.
The main advantage of an EOT sale is that qualifying sales can attract a zero per cent rate of capital gains tax (CGT) – making it highly attractive from a tax perspective.
The vendor shareholders can still remain as employees or directors of the group (albeit not participating in the Trust), post-sale – allowing them to retain a say in day-to-day management.
There can also be significant cultural benefits. An EOT not only helps preserve the brand and culture that shareholders will have worked so hard to build, but can also empower and motivate employees by giving them a greater sense of ownership of the company’s future and its performance.
This makes them a perfect choice for businesses that pride themselves on the strength of their culture, and can ultimately help boost both recruitment and retention.
Shareholders need to mindful that an EOT will usually mean that at least part, and often most, of the value exchanged for the shares will usually be paid to shareholders over a long period of time from the future profits of the business and security cannot be taken by the vendors on those outstanding amounts.
Any minority shareholding that the original shareholders retain will not attract the zero per cent CGT rate if this was to be subsequently sold to the EOT, so planning for exit strategy endgame from the start will be key.
Shareholders also need to bear in mind that there are some qualifying conditions that need to be met.
The vendor shareholders can’t constitute more than 40 per cent of the workforce; the shares acquired by the EOT must be held for the benefit of all eligible employees on the same terms, and that it’s possible that some employees won’t be eligible to be beneficiaries – broadly, those that have held at least a five per cent shareholding in the company in the decade prior to the EOT transaction.
Again, the support of a specialist adviser can be valuable here. They can help assist with everything from share valuation, to financial modelling and forecasting to predict the likely timescale for the payment of deferred consideration, and support securing the relevant clearances from HMRC.
The road ahead
Deciding when and how to exit their business is one of the biggest decisions a shareholder will make. Taking the time to carefully weigh-up and assess all options, and seeking expert support, is key.
At FRP Corporate Finance, we’re experienced at helping shareholders develop their exit plans, from start to finish.
Importantly, we understand that this often won’t just be a practical, financial, decision – it will have an emotive element, too. We work with you to understand your objectives, and your wishes for the company, to find a solution that will both maximise and preserve value for all parties involved.
For more information on how our East Midlands team can support you in your sale strategy, get in touch:
