How Ownership Structure Influences Your Exit

Before considering selling your business, understand how the ownership structure impacts your likely outcomes and the obstacles it creates for getting a deal done. At some point, you will be told by your banker or lawyer that you need to be able to deliver the vote. As they say in Hollywood, you need to know your audience.

Understanding the Types of Ownership Groups

Ownership groups in private companies tend to cluster into three types.

Single Owners

If you own 100%, then things shouldn’t be too complicated. You just need to get good advice as you move through the exit process. You also have the luxury of thinking about how you want to live after the deal. What makes you happy?

But even as a single owner, it is not always so simple.

Charlie took over the family business when his dad passed unexpectedly. Two-thirds of the equity was owned by his dad’s trust for the benefit of his stepmother. Charlie was the trustee of his father’s trust, with a duty to provide for his stepmom. Charlie owned the rest.

One day, he received an offer to sell for 9X EBITDA from a large, public company. He wasn’t considering selling, but the offer was too good.

His stepmom did not want to sell since she enjoyed large distributions from this successful business. But Charlie felt like he was working 70-hour weeks so she could spend the money on her children from a prior marriage.

In this case, there was only one decision-maker, but he had duties to the trust in addition to his own family.

We resolved this conflict by adjusting the mechanism to assess his stepmother’s financial needs. We could keep her in the lifestyle she was accustomed to, but without unfairly enriching her at Charlie’s expense.

Small Group of Owners

Many private companies are owned by a few partners or a small family group who built the business together. A few decision-makers know each other well, but goals and objectives could be far from aligned. Some owners may not net enough cash from an exit to achieve financial security. If they rely on annual distributions, then they are motivated to avoid selling to secure the distributions.

A local family business was owned by two sets of siblings. They were all moving into retirement, and they had just appointed the first non-family CEO. Some wanted to cash out. Others wanted to convert the business to an ESOP for the benefit of the employees and to say thank you for a long, profitable ride.

Their operating agreement said they could only sell to each other, and since they were equal owners, there was no legal means to break the stalemate. Despite years of negotiation, the family has been unable to resolve the conflict, yet they are all getting older.

Large Group of Owners

Our family business had over 100 shareholders spread from Paris to Los Angeles. While the five prominent families knew each other well, about 10% of the ownership was with individuals unrelated to the business or the five prominent families. Their needs and expectations were different and varied compared to the five families, which were mostly in sync with each other.

Since a handful of family members ran the business, some outsiders were suspicious of what was going on. Being disconnected made it hard for them to appreciate the management team’s efforts and the obstacles they had overcome for the benefit of all shareholders.

These dynamics felt more like a public company.

If this is your situation, you should start by reviewing your bylaws and ensure you understand your fiduciary duties to every owner. As in our situation, an investment banker will likely be involved at some point, who, along with the legal team, can help with the education process.

No one likes surprises, so consider the group’s financial acumen. Where do you need to spend more time explaining what you are trying to accomplish? Why is your proposal in their best interest?

With this in mind, here is the analysis you should run before getting ahead of yourself:

How Many Decision-Makers Are There?

What combination of voting blocs do you need to approve the deal? If you have both ‘A’ and ‘B’ classes of stock, you need the ‘A’ to vote to approve and the ‘B’ to not pressure them otherwise. What combination can block the deal? What are their needs and motivations?

Articulate a Clear Set of Goals for the Transaction

Why are we doing this, what is the consequence, and what are our other options? This should serve as a ‘North Star’ for the process and a guide to keep people focused during the ups and downs.

The typical choices are:

•       Maximize net proceeds
•       Secure growth capital
•       Pay down debt
•       Exit a deteriorating market

What will happen to the staff who helped to make you successful? This is likely to be a concern for some owners.

Determine Likely Net Proceeds to Each Owner

Net proceeds are the gross proceeds, less fees, taxes, and debt repayment. Given the likely exit structure, how do the net proceeds impact each owner’s lifestyle? Does it provide financial security forever, or just let them buy a new car? This will be a key driver of motivation. You will want to understand this before trying to sell the deal to the unconvinced. Some of the calculations could be tricky, so consider hiring an accountant, especially if the entity is an S corporation.

The cohesion of your ownership group will influence buyers’ appetites. Buyers do not want to get entangled in your internal squabbles. It is always best to clean these things up before going to market.

In our business, once the insiders decided an exit was needed, there was a long education process to explain to everyone else what we were trying to do and what it would mean to them. A few years prior, we tried a Dutch auction to reduce the number of shareholders, which failed. Many people responded with, ‘Dad told me never to sell!’

However, the company needed significant growth capital, and a leveraged recapitalization was the best answer. Over several months, we had shareholder meetings to explain the goals of the deal, the options, and why we were recommending what we did. There were exhaustive Q&A sessions. You could easily see the differences in financial literacy in the room. However, each question had to be answered to give confidence that management was making the best decision. Eventually, we had the consensus we needed to be confident we were making the right decision.

In most cases, this issue is not surprising or complicated. But sometimes, surprises can change the course of events, and no one likes surprises.

We think you’ll also like:

1. What’s It Worth? Valuing a Business for Sale
2. Asset Sale or Share Sale: Which Seller Approach Should You Use?
3. The Benefits of an ESOP Transaction for the Seller and Company

[Editors’ Note: To learn more about this and related topics, you may want to attend the following on-demand webinars (which you can listen to at your leisure, and each includes a comprehensive customer PowerPoint about the topic):

1. Valuation / What’s it Worth? Valuing a Business for Sale
2. Advertising Aces: Maximizing Reach and ROI
3. How to Prepare for Sale

This article was originally published on August 3, 2023.] 

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