Over the last decade, I have been involved in numerous business transactions, ranging from transfers within families to roll ups with consolidators; sales to financial buyers; and transfers in orderly liquidations, or what I call a “walk away.”
There are many considerations that go into developing a successful exit strategy, but some of the lessons and stories I am going to share in this article occurred in transactions with which I have been involved.
The stories relate to the following issues:
Disastrous family planning, such as including all the family members in the business ownership, where some members were unqualified to be business owners, eventually resulting in a dissenting shareholder law suit
Timing: In a hot economy, strategic opportunities can be abundant.
Leverage: A company may be making a profit but has too much debt-financing. What happens here is that working capital dries up, and with expensive financing the company is virtually forced to make a deal in order to avoid a bankruptcy. This type of a transaction, when it takes place, is known as a defensive transaction; you are not in control of the outcome because of your weak financial position, and the net result ends up being either an underlying asset sale at best or one form of a liquidation, either orderly or forced, depending on the severity of the situation.
The opposite of leverage – being an offensive seller (no debt): The sale of the business is on your terms.
I’ll begin with what I consider to be one of the poorest examples of family planning ever. This particular company was a huge agricultural conglomerate with multiple businesses. There were three family members who inherited the business; two of the three siblings had the intellectual capacity to manage and grow the businesses. Guess what happened? The less capable brother filed a law suit to dissolve the company because he felt the entity had been managing its operations inappropriately (in other words, he wasn’t able to take as much money out of the business as he had hoped).
So what happened? The legal system took over. The family was entrenched in a decade-long battle trying to resolve the litigation started by the unhappy brother who was a minority shareholder. What was the cost of the transaction? The two brothers who were running the company died during the lawsuit period. And the cost in financial terms? Tens of millions of dollars.
After all of this nonsense, the company was ultimately split up, and the assets were distributed to various heirs of the family. How could this have been prevented? The parents knew all along that there were different skill sets among the brothers and could have put a plan together in advance to divide the assets. With this type of planning a mess like this could be avoided, early deaths of family members due to stress may not have happened and from a financial standpoint millions of dollars in unnecessary legal and expert fees could have been avoided.
My next story is about a combination of too much debt, not enough working capital, tough economic times and an industry that is very competitive with tight profit margins. The combination of these issues could have resulted in the ultimate disaster but actually resulted in a happy ending.
This company had survived for nearly half a century in the community through a purchase by the original founder, a transfer to two extremely well-qualified family members, but then a sale of the company at a price that was considerably less than what the owners had hoped for. So what went wrong?
It was the combination of tough economic times, not enough working capital and a very competitive industry with thin profit margins. How did we rectify the situation? Simple. We went to the main supplier and made them a “deal they couldn’t refuse.” The supplier purchased the assets of this particular company, offered excellent jobs to the two shareholders, and the deal was done. One of the former shareholders is still with the company, the other chose to seek other opportunities and is doing very well in his own right. What was the lesson learned here? The shareholders realized that their business model could not be sustained with the current economic climate, and they made a deal and moved on. This was a great move, and everyone came out fine.
My final story is everyone’s dream for exiting a business. The economy was thriving, the owners didn’t have to sell and a consolidator approached my clients and asked them, “What is it going to take for us to purchase the business?”
This was a fun assignment for me. All I had to do was sit down with the clients, come up with an after-tax net cash flow that they would be willing to accept to sell the business, and the deal was done! The consolidator met our number, and the clients were cashed out.
In summary, these “lessons to be learned” give perspective to what can happen when you have planned correctly and also what can happen if you refuse to “take a reality check” and don’t plan at all.
Luck and timing are often significant; however, if you don’t plan correctly you are setting yourself up for failure, and luck and timing will never come into play.
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Jim Andersen, CPA/ABV/CFF/ASA and founding partner of Andersen & Company, is now a partner in the consulting-business valuation and litigation practices of Burr Pilger Mayer (BPM) in Santa Rosa. For more than 20 years, Jim has been taking North Bay businesses through the business valuation and succession planning process. You can reach him at 707- 524-6530 or via e-mail at jandersen@bpmcpa.com.
