What is an exiting business owner to do in order to achieve the exit that they are looking for during these challenging economic times? Here are a few creative strategies to consider.
The US economy is firmly in a recession. Heading into 2009, business owners will need to recognize that the capital that they generally have required for running and growing their businesses is equally important to their exit plans. As a result, when credit contracts, the ability to finance an exit become yet another challenge to an owner’s exit. The good news to this problem is that necessity is the mother of invention and a few creative strategies can be employed to make adjustments for your exit.
The first point to recognize about your business exit is that you are not likely to get all of the proceeds for your exit at the time of your departure. Whether you are selling to an outsider or a private equity group, or you are conducting an internal transfer such as an employee stock ownership plan (ESOP) or a management (or co-owner) buyout, you are – under normal circumstances - not likely to get 100% of your transfer proceeds at the closing.
Now, as consumers of large ticket items - take for example real estate – we generally do not write a check for the purchase out of our savings accounts.
Instead, we go to the sources of capital that would normally finance those transactions – in this case, the banks. The bank wants to know three things when they loan money:
Well, in ‘normal’ times it can be an uphill battle to illustrate that an investment in a privately-held business will have the capacity to repay the loan. In today’s environment, the challenge is even greater.
So, what is an exiting owner to do in order to achieve the exit that they are looking for?
Be the Bank
First, owners should know that they have the ability to ‘be the bank’. Owner financing is more prevalent in internal transactions and in smaller transactions (less than a few million dollars) where the buyer (or successor) generally does not have the ability to borrow enough money to purchase the business.
If the buyer or successor cannot achieve bank financing, it is helpful to know that you, the exiting owner, can benefit by ‘being the bank’. After all, you know the answer to all of the three lending questions:
1. First, the use of the proceeds is for your buyer or successor (or employee stock ownership trust) to purchase the business (or a part of the business) so that you can exit with the loan payments funding the purchase of the shares as the loan is repaid.
2. Second, you know that the funds will be repaid by the business itself. For internal transfers, you do not need to totally give up control of the business as part of the transaction. Here, milestones can be established and the shares of stock can be ‘released’ to your buyer / successor as the loan is repaid.
3. Finally, your back-up plan if the loan proceeds are not repaid is either taking back control of the assets in the case of an internal transfer – the business itself which served as collateral for the purchase. For an external transfer, you can get corporate and personal guarantees for repayment - go to the “deepest pockets” in the transaction for these guarantees.
Making Money with Your Money
There is an additional benefit to serving as the bank, namely that you will be able to charge interest on the loan that you have extended to the purchaser of your stock. In fact, many exiting owners take comfort in the notion that they will be earning 8 or 9 or 10 percent annual interest on the proceeds that are owed to them.
In this respect, the exiting owner is once again further compensated for the risk that they are assuming with the loan. This is no different than the posturing of a bank in making this type of financing available. Only here, you, the exiting owner, are the bank and someone else is paying interest to you.
Valuation
Many exiting owners who have provided the capital, via ‘owner financing’ have found that the buyer / successor is willing to pay a higher price to acquire the shares of stock. This makes sense for a few reasons. First, the buyer / successor would not be able to complete the transaction without your financial assistance. Second, you may be able to structure the payments so that the buyer / successor pays – and you receive the payments – in a tax-efficient manner, over a number of years.
When you can negotiate the financing of a transaction with your buyer / successor under these terms, you hold the same position that the bank holds in a transaction. Your consent and approval as both the seller and the financing source are required to complete the transaction. This gives you another leverage point to negotiate for a value that meets your financial goals for your exit – which is the final point.
Reach Your Financial Goals
Once the risk of ‘being the bank’ has been assessed, it is critically important to measure whether or not the proceeds (plus interest) will be sufficient to reach your post-exit goals. Once again, the ability to reach your financial goals is one of the primary objectives of most exiting owners. Therefore, if you can get comfortable with the riskiness of the payments that are owed to you, you can begin to design a customized plan to receive the proceeds.
Again, there is a risk that the proceeds will not come your way if the business fails. However, if this risk is low enough, your tax and legal advisors may be able to structure a very tax-efficient exit that bridges your financial gap and allows you to meet your post-exit expenses.
Conclusion
In short, an owner needs to be creative with financing sources when bank loans are not available to finance an exit. When you can begin to think in terms of being available to provide the financing for a transaction, you can engage the exit planning process and take the necessary first steps towards protecting the illiquid wealth that is trapped inside of your business. Give some thought to playing banker for your exit and you just may find that a creative solution for your exit appears from this type of thinking.
© John M. Leonetti
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