Is business ownership a binary thing? Do we either own our businesses or not? I’ve mentioned this concept before and it is worth discussing in more depth. The binary notion leads business owners to think in terms either of the status quo or of an eventual sale of the business.
Bookends: Status Quo and Third-Party Sale
The truth is that between the two bookends of status quo and an eventual third-party sale are many possibilities for creating shareholder liquidity and diversification opportunities and facilitating both ownership and management transitions. Let’s look at the bookends, either status quo or third-party sale:
- Status Quo. First, let’s talk about the either. The status quo may be an excellent strategy. If sales and earnings are rising, existing owners can benefit from the growth and expected appreciation in value and maintain control of the business. However, the status quo, in many instances, does not provide liquidity and diversification opportunities for owners and places all execution risk on them. A decision to maintain the status quo for your business may not do much to advance necessary ownership and management transitions, as well. So a decision to maintain the status quo should be based on conscious decision-making and not on procrastination. And the status quo has an insidious side to it – unless you and the other owners do something, you will stay in the status quo for a long, long time. So you have to question the status quo on an ongoing basis.
- Third-Party Sale. Now, let’s talk about the or. If your business is continuing in a status quo mode, chances are you are not preparing the business for an eventual sale. After all, it will happen someday. Chances are also that you and the other owners may not be preparing yourselves for an eventual sale. If you are maintaining a status quo status, you may not be able to influence the timing of an eventual sale. The ideal time to sell a business is when the markets are hot, when financing is readily available, when your business is tracking upward and has a good outlook, and when the owners are ready. In reality, what you can hope to achieve in a sale of your business is the best pricing available in the market at the time of the sale. If you remain in the status quo, you may not get to choose the timing of the eventual sale.
If it seems like I am painting an eventual third-party sale as an unfavorable outcome, I am not. It can result in an unfavorable outcome, however, if your business is not ready for sale at the time of a sale and if you and your other owners are not ready personally for that eventual sale.
What Lies Between the Bookends?
Managing illiquid, private wealth in the context of The One Percent Solution requires a more active role for business owners and a different level of attention on the business itself.
The status quo and an eventual third-party sale are, indeed, bookends. Look at the table below.
If we are managing the wealth in our closely held and family businesses, we will be focused on creating liquidity opportunities over time and on achieving reasonable returns from our companies on a risk-adjusted basis. We will be using our companies as vehicles to generate liquid wealth and diversification opportunities over time.
The table above shows the bookends of status quo and third-party sale options. In between are a number of options that owners of successful private companies can use to manage the wealth tied up in them and to create ongoing opportunities for liquidity and diversification.
The table is certainly not all-inclusive, but it does include some easily implement able options like establishing a dividend/distribution policy or making occasional share repurchases is owners need some liquidity or, for example, when an owner leaves the company. This purchase might be pursuant to the terms of a buy-sell agreement. If your company has significant excess assets, it is probably a good idea to clean up your balance sheet and declare a special dividend. It may also be appropriate to have one or more key managers acquire small stakes in the company to facilitate alignment and future management transitions.
I call these options “easily implemented,” but they won’t happen unless someone does something.
The next category of options in the table is termed “significant & realistic minority options.” We will address them in more detail in subsequent posts, but they include relatively small leveraged dividend recapitalizations or share repurchases. The options also might include the creation of a 30% or less ESOP in appropriate circumstances. These transactions certainly won’t happen without someone doing something. They will likely require the assistance of outside expertise, and there will be certain transaction costs. Transaction costs should be considered in the context of investments and The One Percent Solution.
The third category after the status quo is called “control-level options.” For some successful private companies, it may be appropriate to engage in substantial transactions to create liquidity opportunities and to retain ownership in expected future growth and appreciation.
The final category is the bookend of third-party sale transactions.
It should now be clear that there are options other than selling a business today, or simply maintaining the status quo, for managing the illiquid wealth in your private company.
Benefits of the Options Between the Bookends
The shareholder benefits of employing one or more of the above strategies over time include the following:
- Acceleration of cash returns, liquidity opportunities, and opportunities for diversification and creating liquidity independent of your company
- Ability for your owners to diversify their portfolios
- Optimization of your company’s capital structure with reasonable leverage
- Enhanced return on equity with reasonable leverage
- Enhanced earnings per share for some options
- Planned changes in ownership structure with shareholder redemptions, with remaining owners achieving pickups in their relative ownership of the company
- Enhanced performance and reduced business risk with focus on the business
Employing one or more of the above One Percent Solution strategies is tantamount to using modern investment theory concepts and basic corporate finance tools in the management of illiquid private company wealth.
These techniques work for others, including many private equity firms that engage in leveraged dividend recapitalizations and leveraged share repurchases to maximize shareholder returns and to facilitate future growth in value for their investments. These basic options can also work for you.
Most all of the fun and learning is found, not at either bookend, but in between them.
As always, please do call me at 901.685.2120 if you wish to talk about the ideas in this post.
Until next time,