EXIT STRATEGIES FOR SMALL BUSINESS OWNERS IN NEW ZEALAND
by Henry Brandts-Giesen and Silvia McPherson of Dentons Kensington Swan
Understandably when someone sets up a new business the exit strategy is not usually the main focus. Often it is not even considered. However, every small business owner should have an exit strategy.
In theory, selling or transferring to a family member should be one of the easiest exit strategies. However, the reality is that family business succession is often complicated. Never think this is a science, it is all about human behaviour around money which is often irrational. It is complicated but a family succession is a goal worth striving for. If we get it right there are significant social and economic benefits to be gained from having a strong family business sector in New Zealand.
Management Buy Out
An MBO involves the management team pooling resources to acquire all or part of the business they manage. Most of the time, the management team takes full control and ownership, using their expertise to grow the business.
An MBO can allow for a smooth transition. If the strategy is set early then employees who know they have the option to buy out the founder tend to work harder to make a success of the business. An effective MBO can be a relatively low risk exit strategy with the new owners more likely to bring along the key employees, clients and business partners.
Selling to employees can be done in a few ways. In New Zealand it is common for a simple sale and purchase event to occur at a designated time but an MBO can also be phased in by an employee share scheme, which is a plan that allows employees to acquire ownership in a company over time.
Merger, Acquisition or Roll Up
This is the consolidation of companies or assets through various types of buying and selling. A merger involves the merging of a business with a similar company, while an acquisition simply means a business is bought by a larger company or a private equity fund. A roll up is where various independent but similar businesses are consolidated.
Common reasons for a merger, acquisition or roll up include:
- Resolving a succession conundrum.
- A quick path to expansion.
- Combining complementary skills and pooling resources.
- Shutting down competitors.
- Achieving economies of scale.
Winding up the business can be a legitimate and effective exit strategy. This is especially so for a small business that depends on a single individual.
Winding up a business is relatively simple as it usually involves a simple asset sale. But, asset sales in a wind up are rarely profitable. There is usually no price to be paid for goodwill, client databases, loyal employees and other intangible assets and second-hand equipment is rarely sold efficiently and at worthwhile prices.
Whilst it seems counter-intuitive, draining the business is a legitimate option where a small business generates cash flow without needing much attention or capital from the founder. Similarly, where the business is likely to be disrupted in the short to medium term and would require significant capital expenditure to pivot into a more sustainable business model.
In such situations the founder usually invests nothing into the business and withdraws all or most of the profit over time until there is nothing left of the business.
If the strategy is set early and employee and creditor interests are properly provided for, then liquidity can be systematically diverted over time from the business into other more sustainable and succession ready asset classes (such as professionally advised and managed financial assets).
Initial Public Offering
An initial public offering (IPO) is the first sale of shares issued to the public. While not applicable to most small businesses in New Zealand, it can be very profitable in the rare circumstances where the business defies normal growth projections and has the resources to deal with the compliance burden of being a listed company.
Recent capital raising innovations like crowd funding may be more appropriate for businesses starting up rather those at the other end of the business life cycle.
There are of course other exit strategies. As to what strategy is best for the business will depend on a range of factors and circumstances. However, small business owners and their advisors in New Zealand could benefit from being strategic rather than solely transaction focused.
The best time to develop an exit strategy was when the business was founded. The second-best time is today.