One of the questions we get asked the most frequently is why are our clients selling their companies. There seems to be a suspicion that a sale could be motivated by bad news or could be signaling a lack of belief of the owner/manager in the business.
Actually there are a multitude of reasons why company owners decide to sell a stake or all of their business, and I list them here from the most common to the least.
1. Injecting new equity into the business
The most common reason for selling shares is to finance the business. In this case, the new cash goes into the operations and is used for building new facilities, hiring more people, marketing etc… The existing shareholder gets diluted and the transaction makes sense as the smaller stake becomes bigger in absolute terms than the original pre-dilution stake.
It is very important to understand this concept as most other forms of equity financing or “business sale” (with the exception of the full business sale) have a component of financing in them one way or the other.
2. Partial exit to share the risks (and rewards) of the business
Sometimes entrepreneurs or business owners do not require much financing but are interested in selling some of their equity in order to raise cash. In this case the business owner remains on board as the leader of the business, whether their final stake is a majority or a minority. In any case, the new investors are making a huge bet on the business leader and baking their strategy.
Why would an entrepreneur be “Reducing risk”? Does it mean the business is “too risky” or a bad business? Not necessarily, and, actually if it was the case neither us nor other credible M&A advisors would be taking the mandate (as it would be impossible to execute). Actually, it is good best practice from a diversification perspective for an entrepreneur to create some liquidity and invest in other assets than his main business, such as real estate or public equities, or even other uncorrelated businesses.
This could also be a form of financing the business, or sharing the costs of the financing. For example, if a business is highly cash-flow generative but is contemplating a major expansion or capex program, the sole shareholder may wish to share the risks of such an effort with new partners. Particularly f the new partners can bring other value added to the table such as sector expertise or management skills.
3. Mixed partial exit and growth financing
This option probably captures most of the transactions we work on. We sit down with business owners and identify their objectives including equity risk sharing and business financing and devise the optimal mix of primary and secondary capital, as well as the ideal investors and partners for the business in its next phase of growth and development
4. Bring in new skills to the table
As a business goes through its growth phases, the leaders who created the business will realize at some stage that they prefer working in a high growth / high risk business rather than managing a large stable business. Sometimes management is more suited for operations in a single geography and does not enjoy the glamour of international business travel that is required for international expansion. Or the business needs to be transformed from a “Ma and Pa” family run business into an institutionalized structure which requires a more complex org chart, and family business owners may neither have the taste nor the experience to effect such a transformation.
Bringing in “consultants” to recommend the best practices is a logical but very experience and sometimes unproductive solution. Bringing in private equity investors who have “Skin in the game” and are heavily incentivized alongside management to create value can be a surprisingly efficient way to affect change and transform a business. This can be particularly effective ahead of an IPO or in preparation for a more substantial second round of equity rising.
5. Full exit
Although there is a lot of literature in the western markets, about company transmission, we come across this more rarely in our Dubai practice. Indeed the countries we operate in are quite young and most successful businesses get passed from a generation to the next or go public. However, we are starting to come across the scenario of an owner retiring with no obvious family heir.
This is a classic case of full business sale which we expect we would encounter more and more as our economies mature. Again, a natural election process where only those businesses which have been institutionalized enough so that they can be successful beyond the first generation and are less dependent on the vision and drive of a single person, will be successful.
More on the theme of company sale, and particularly on how to create value for existing and new shareholders, in our next blogs.
February 21, 2015
CEO at Awad Capital