The issue of an exit strategy remains challenging for private companies, especially family-owned businesses. Much of the wealth of owners and founders is tied to the enterprise, and at some point, they will want to monetize. When succession isn’t feasible for a family business, and with the decline in the stock market limiting an IPO exit for many start-up founders, a sale is the next likely option. As an owner, founder or entrepreneur contemplating a sale—or an advisor working with a family office—you need to start preparing now for a successful transaction in the future.
According to 2021 data from PwC, only 34% of U.S. family businesses have a documented succession plan. The Family Business Institute reports that 30% of family-owned businesses survive into the second generation, 12% into the third generation and only about 3% are still operating into the fourth generation and beyond. The first transition has dropped to 19% in the last five years, the Family Business Center says, due to millennials declining to take over the family business, selling it and using the proceeds to start a different family-owned enterprise. EY notes that only 3.5% of all next generation members want to take over their parents’ firm immediately following graduation.
The good news is, while M&A and IPO activity is down from 2021 in the current market, private equity sponsors have plenty of what is known as “dry powder,” committed but unallocated capital, to make acquisitions. According to S&P Global Market Intelligence data reported by Yahoo Finance, Q3 2022 was the worst quarter for global M&A since the start of the Covid pandemic, with deals down 58% from the same period last year. In 2022, global IPO volumes dropped 45% and number of deals by 61%, according to EY. At the same time, according to Pitchbook, PE firms had some $1.2 trillion in dry powder to spend as of Q3 2022.
Given this scenario, how do you make your company attractive to a potential acquirer so that you can achieve maximum valuation and close a beneficial deal? Here are several recommendations for owners, founders and entrepreneurs, and the advisors who counsel them.
Secure an enterprise valuation. You should get an outside valuation of your company that is industry specific and will provide an assessment of the multiple you realistically can achieve in a sale. The drop in the stock market, inflation and rising interest rates all have led to a decline in private market deals and VC funding, with a consequent decrease in private company valuations. In this environment, it is important to have an idea of your optimum pricing before marketing your company.
Strengthen your cash flow. They say that cash is king, and this motto certainly holds true in a sale transaction. A company with a strong and steady cash flow is much more attractive to a potential acquirer, particularly a private equity sponsor.
Make sure your books and records are clean. Many small businesses don’t have audited statements, which are necessary to demonstrate the financial credibility of your company. You should get audited statements from a reputable accounting firm that go back two or three years before the prospective sale.
Be prepared to be a minority stakeholder. Some PE sponsors may only want to acquire a stake in your company and so will require you to continue to have skin in the game. You should also cover expenses that new owners will net out, such as a company car and your other non-recurring expenses.
Realize that you’ll no longer be the ultimate boss. Ceding control of your enterprise constitutes a big transition. Many private company and small business owners and founders make split-second decisions on the fly. Continuing as an interim chief under a new owner or working with a PE sponsor who holds a stake in your company means realizing that you will have to answer to someone else.
Consider your staff. You may want to structure the deal so that your top key executives or long-time employees also receive equity or some sort of payout.
Allow for tax planning. A company sale will provide a financial windfall and you should think in advance about the tax implications. Also to be considered are what you will do with the proceeds and whether the sale of your liabilities will be part of the transaction.
While succession in a private company or family-owned business can be problematic, and an IPO impractical for many founders in current market conditions, a potential sale doesn’t have to be. Take some steps now to prepare for an exit, and your deal could be a portal to new opportunities in the future.
John Yoler is executive vice president and U.S. head of commercial & industrial for commercial bank BHI, the U.S. division of Bank Hapoalim. Bank Hapoalim provides its clients access to a broad array of products and services available through its bank and non-bank affiliates. Not all products and services are provided by all affiliates or are available at all locations. All credit products are subject to credit approval. Nothing contained herein should be construed as a commitment to lend by BHI or any of its affiliates. The matters discussed herein express the personal views of Mr. Yoler and are not necessarily those of BHI or its affiliates.