SDR Ventures’ consultants examine potential value-creation strategies through its Strategic Business Planning Processes and its Growth and Expansion Strategy processes to identify value creation opportunities. A number of value creation strategies could be considered:
Recent separations have addressed value creation through optimizing asset mix, capital structure or earnings and cash flows. For example, companies facing these kinds of situations could be candidates for corporate separations.
- Companies facing persistent undervaluation of segments or subsidiaries or substantial discount to the “sum-of-the-parts”
- Operations of a subsidiary are non-core andor have limited synergies
- Management of the combined company is a drain on management time and resources
- Earnings/Cash flow of the parent/subsidiary is a drag on the other
- Capital Structure is sub-optimal for the subsidiary
- Brand/Image/Reputation considerations
The tactical decision regarding separation must balance a number of financial and operational goals. These goals include: enhancing strategic focus, optimizing capital structure, tax efficiency and earning profiles and realizing value enhancement.
SEGMENTING CASH FLOWS
A number of public companies have pursued carve-outs of a target portfolio of cash-generating assets. These range from midstream pipeline and shipping Master Limited Partnerships (MLPs) to power generation assets offering a substantial yield to shareholders. In each of these situations, a large public company targeted a group of new investors who were attracted to tax-efficient cash flows with long duration profiles, creating significant value for shareholders.
SALE AND LEASE BACK OF EMBEDDED ASSETS
Companies may find that they have embedded assets that are undervalued such as real estate, plant and equipment or technology that could be sold and then leased back to improve the balance sheet and retained earnings.
REVERSE MERGER WITH A PUBLIC SHELL
This strategy can create significant value to the shareholders in the following ways:
- Increased Valuation: Publicly traded companies may enjoy substantially higher valuations than private companies.
- Capital Formation: Raising capital may be easier because of the added liquidity for the investors, and it may take less time and expense to complete an offering.
- Acquisitions: Making acquisitions with public stock may be easier and less expensive.
- Incentives: Stock options or stock incentives can be useful in attracting management and retaining valuable employees.
- Financial Planning: Public company stock is often easier to use in estate planning for the principals. Public stock can provide a long term exit strategy for the founders.
- Reduced Costs: The costs may be significantly less than the costs required for an initial public offering.
- Reduced Time: The time frame requisite to securing public listing may be considerably less than that for an IPO.
- Reduced Risk: Additional risk is involved in an IPO in that the IPO may be withdrawn due to an unstable market condition even after most of the upfront costs have been expended.
- Reduced Management Time: Traditional IPOs generally require greater attention from senior management.
- Reduced Business Requirements: While an IPO requires a relatively long and stable earnings history, the lack of an earnings history normally does not keep a privately held company from completing a reverse merger.
- Reduced Dilution: Typically there is less dilution of ownership control, compared to a traditional IPO.
- Reduced Underwriter Requirements: No underwriter is needed. (This is a significant factor to consider given the difficulty that companies may face in attracting an investment banking firm to commit to an IPO.)
BILATERAL OR CONSTELLATION ALLIANCES
Becoming part of a bilateral alliance or an alliance constellation, like the airline industry’s Star Alliance, can help a company compete and win. Companies can compete and win by using a constellation of allied firms. We define a constellation as a set of firms, linked through alliances.
- Linking Markets: Companies sometimes form constellations to connect local markets and, in the process, provide customers with broader geographic coverage.
- Combining Skills: Companies also form constellations to assemble a diverse basket of skills, sometimes to launch a totally new business.
- Building Momentum: Constellations are also used to create market momentum – that is, to persuade customers, suppliers or competitors to adopt a new technology or business protocol.
- Reducing Costs: On occasion, companies form constellations to reduce costs.
- Sharing Risk: Companies also assemble multiple partners to share large investments or risks.
Smart deal making is at the heart of many successful companies. So what separates the successful and unsuccessful dealmakers? Successful dealmakers execute a series of small, low-risk deals rather than attempting to pull off complex acquisitions. In this way, they sharpen their skills at acquiring and integrating companies, gradually scaling up to larger deals and institutionalizing a success formula. Smart dealmakers also focus on the critical decisions that make or break a deal, so they don’t have to waste time on excessive number-crunching or inch-by-inch integration. They follow four key imperatives:
- Targeting deals according to a sound investment thesis;
- Determining which deals to close by asking and answering the big questions;
- Prioritizing which aspects of the businesses to integrate and which to leave independent; and
- Developing contingency plans for when deals inevitably go off track.
Research indicates that 80% of those with a net worth of $5 million or more are entrepreneurs who sold their businesses. Yes, real wealth is not made simply by starting companies or growing companies. Real wealth is made by selling your company, especially by selling to an acquirer who will pay a premium because the acquirer believes it can generate even more value from what you’ve built. However, the premium paid for any company is based on the “value created” by the existing shareholders over time, as previously discussed.
In order to attract an investor for your business, whether it is growth capital or a sale, it is important to plan and prepare from 12 to 24 months (and sometimes longer) ahead of going to the investor market place. There are four “Knows” that are critical to the success of attracting investors.
- Know your Industry
- Know your Company
- Know your People
- Know to Plan and Prepare for the Investor
In the last two years, the “buyers” market has become much more robust due to two major drivers. First, the stock market has been robust, enriching buyers’ net worths. Second, buyers are looking to accelerate their growth through acquisitions. Buyers typically fall into two general categories.
You need to prepare for both. Each will have a different focus and therefore will affect the deal structure. Depending on the investor, there are a number of exit plans to consider. Regardless, when preparing to execute an exit strategy, careful planning is critical to ensure that the transaction and post-transaction go smoothly. Planning for the transaction takes in four broad areas.
- Valuation of the Business
- Clean Financial Statements and Realistic Projections (Audited financials may be required)
- Tax and Legal Considerations and Analysis
- Wealth Management Planning
In addition to our network of independent senior consultants, we have strong relationships with some of the leading law firms, accounting firms, investment banking firms and wealth planning firms in the U.S. If you so desire, we help you select the right firm(s) to form a team that has the subject-matter expertise and depth of experience needed to provide you with the most up-to-date expert advice when preparing and executing an “Exit Strategy.” With SDR Ventures, your interests are paramount as you consider other professional advisors.
Many privately held company owners and shareholders believe that an IPO is their best avenue for value creation and an exit strategy for themselves. And in some cases they may be right. But the IPO market is complicated and unpredictable.
So why do so many private companies want go public?
Going public can raise lots of cash. Being publicly traded also opens many financial doors:
- Because of the increased transparency, public companies can usually get better rates when they issue debt.
- As long as there is market demand, a public company can issue more stock. Thus, mergers and acquisitions are easier to do because stock can be issued as part of the deal.
- Trading in the open markets means liquidity. This makes it possible to implement things like employee stock ownership plans, which help to attract top talent.
- Being on a major stock exchange carries a considerable amount of prestige.
- It is one of the best avenues for issuing a secondary offering.
In the past, only private companies with strong fundamentals could qualify for an IPO and it wasn’t easy to get listed. The internet boom changed all this.
Some firms no longer needed strong financials and a solid history to go public. Instead, IPOs could be done by promising smaller startups seeking to expand their businesses. There’s nothing wrong with wanting to expand, but most of these firms had never made a profit and didn’t plan on being profitable any time soon. Founded on venture capital funding, they spent heavily, trying to generate enough excitement to make it to the market before burning through all their cash. In cases like this, companies might be suspected of doing an IPO just to make the founders rich. This is known as an “exit strategy,” implying that there’s no desire to stick around and create value for other shareholders. The IPO then becomes the end of the road rather than the beginning.
There are other opportunities for creating value including Spin-Offs, Spit-Offs, Carve-Out IPOs, Equity Carve-Out and Tracking Stocks.
As you can see there are many Value Creation Strategies that can be used to reach your valuation goals. We can help you evaluate which of the Value Creation Strategies is right for you.
These early investors look for a high return and an exit strategy in approximately three to seven years. They work almost exclusively with companies that may go public or can be sold for a significant profit. However, keep in mind that going public still remains relatively rare and is likely unattainable for most small or smaller middle-market companies.
OTHER POSSIBLE EXIT STRATEGIES TO CONSIDER:
- Management Buy-out with cash and/or an earn out
- Sell to private equity firm
- Buyout by partner in business
- Franchise the business
- Hand down the business to another family member
EXIT STRATEGIES FOR LONG-TERM INVOLVEMENT FOR SMALL TO SMALL MIDDLE MARKET PRIVATE COMPANIES
- Let it run dry: This can work especially well in small businesses like sole proprietorships. In the years before you plan to exit, increase your personal salary and pay yourself bonuses. Make sure you are on track to settle any remaining debt, and then you can simply close the doors and liquidate any remaining assets. With the larger income, naturally, comes a larger tax liability.
- Sell your ownership: This works particularly well in partnerships such as law and medical practices. When you are ready to retire, you can sell your equity to the existing partners or to a new employee who is eligible for partnership. This can be structured on an “earn-out” basis for a three to 10 year period. You leave the firm cleanly, plus you gain the earnings from the sale.
- Liquidate: Sell everything at market value and use the revenue to pay off any remaining debt. This is a simple approach, but also likely to reap the least revenue. Since you are simply matching your assets with buyers, you probably will be eager to sell and therefore at a disadvantage when negotiating.
EXIT STRATEGIES FOR SHORT-TERM INVOLVEMENT
- Go public: The dot-com boom and bust reminded everyone of the potential hazards of the public stock market. While you may be sitting on the next Google, IPOs take much time to prepare and can cost anywhere from several hundred thousand to several million dollars, depending on the exchange and the size of the offering. However, the costs sometimes can be covered by intermediate funding rounds.
- Merge: Sometimes, two businesses can create more value as one company. If you believe such an opportunity exists for your firm, then a merger may be a good way to exit. If you’re looking to leave entirely, then the merger would likely call for the head of the other involved company to stay on. If you don’t want to relinquish all involvement, consider staying on in an advisory role.
- Be acquired: Other companies might want to acquire your business and keep its value for themselves. Make sure the offered sale price meshes with your business valuation. You may even seek to cultivate potential acquirers by courting companies you think would benefit from such a deal. If you choose your acquirer wisely, the value of your business can far exceed what you might otherwise earn in a sale.
- Sell: Selling outright can also allow for an appropriate exit. If you wish, you can take the money from the sale and sever yourself from the company. You may also negotiate for equity in the buying company, allowing you to earn dividends afterwards — it clearly is in your interest to ensure that your firm is a good fit for the buyer and therefore more likely to prosper.
For further information regarding SDR’s strategic consulting capabilities, please contact:
Managing Director, Consulting Division