ESOP transaction exit plans differ greatly for different sized businesses. Business owners need to know where they fit on the exit planning transfer spectrum as well as how to begin your exit planning today.
The Exit Planning Transfer Spectrum
The exit choices that are available to privately-held business owners are largely dependent upon the size of the business. In our case, well generalize by measuring the size of a business both in terms of revenue, the number of employees, and annual profits. The Exit Planning Transfer Spectrum below will assist you in seeing where you fit.
As a solo-preneur you have a job. Someone else needs to want to do your job, in your place, and you need to find that person to own your business after you. This applies to many private practitioners such as lawyers, doctors, dentists, accountants, etcwho work on their own. Conveniently, some trading markets have developed for these businesses, as well as some standards for deriving a value for your solo-preneur business (the most typical being 1 times annual revenues, which means that if your business generated $350,000 in top-line revenue in the prior 12 months, then that may be the approximate value of the business). Another important issue relates to licenses required to conduct the activities of the practitioner. The requirement of a license (and appropriate training and experience) limits the potential buyer pool, making many smaller businesses more difficult to sell. Finally, most buyers of solo-preneur businesses DO NOT pay cash up front for the business. Rather, a nominal amount is made as a down payment and the balance is paid over time. Remember that as a solo-preneur, you are selling a job, not a company (unless some valuable intellectual property exists, but these situations are rare). You can either mentor someone to learn your job (perhaps a family member) or you can sell your business to another individual either on your own (not recommended) or through a business broker.
The Micro-Business: The 5 to 15 person company
The next type of business in the exit planning transfer spectrum is the 5 to 15 person company, micro-business. This business often times still has a solo-preneur running the company and that owner has been able to hire other people to assist with processing the work that comes in. In most of these situations, the workers in the company report directly to the owner and the owner is very involved in the day-to-day running of the business. In fact, without the owner, there really would not be a company. Most of these owners started as great craft-people who found enough demand for their products to add a basic support team to assist with the business generation and servicing roles in the company. Nonetheless, the employees are, in most cases, simply executing on the owners directives. Although the employees communicate with each other on a regular basis, most, if not all, of the critical decisions are made by the owner. In fact, even if some management is in place, a deeper look at these business usually shows that the manager is actually more of a supervisor without any real decision-making authority.
The Lower Middle-Market Business: The 15 to 50 person company
It is hard for a business to get up to 15 to 50 employees without some form of management structure in place. At this point in the businesses growth, these managers often times have incentive plans in place and have a good amount of decision-making authority delegated to them, which assists in the growth of the business. This is where companies begin to reach the multi-million dollars in sales volume and start to attract enough customers and have enough infrastructure and profitability to be attractive as an acquisition candidate. There are really 2 versions of a management team that exist at this level.
First, is the vertical model of management. This is where the entrepreneur is at the top of the business and is heavily reliant upon a second in command to run the business. The second in command actually runs the day-to-day of the business while the entrepreneur at the top remains the strategist and the visionary. The second in command handles the majority of the personnel and other issues within the company while the entrepreneur brings in the business with the assistance of the supporting team.
The Upper Middle-Market Business: The 50 to 200 or more people enterprise
When a company reaches the point of 50 to 200 or more employees there are generally departments that function on their own with empowered managers to make decisions and take responsibility for the business generation and profitability of their division. The owner or owners at this stage are only taking in the information that is critical to them making decisions and are not getting involved in the minutia of the day-to-day functioning of the business. These enterprises start to become very attractive to the many professional investors as well as to strategic industry players and competitors. The reason for the attractiveness is that this company has enough demand from the marketplace to have a sizeable percentage of business but the company also is designed to be scaled to potentially a much larger enterprise. The exit planning techniques for a business this size will often times revolve around the communications and incentives that are put in place for the key managers as well as establishing a consistent trend of growth that is supported by solid projections and a story of independent and effective execution from the management team on a proven basis.
The size of your company will determine the things that you need to do to prepare for a successful exit. Planning is needed to have a successful exit designed and customized for your unique needs. However, this article was written to get you started on the process and to begin to ask the right questions of your exit consultant as you head down the exit path.
Is an ESOP right for your company?
If you would like further information about ownership transition options, please contact us. SES Advisors welcomes the opportunity to provide complimentary and confidential advice.