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Breaking down the ins and outs of partial exits

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A decade ago, partial exits were a fairly rare occurrence for entrepreneurs. The main reason for this was that private equity houses weren’t too keen on them. They were worried that if a founder took millions off the table, they wouldn’t be incentivised to grow their business anymore. Without that appetite from financial backers, many entrepreneurs likely didn’t consider this a viable option in their business planning.

But in recent years, the perception has changed and there’s more of an appetite for partial exits amongst private equity houses in particular. As private equity has competed for strong businesses, the market has woken up to the idea that cash out for a founder can be a big driving factor in making a deal work. This shift has meant that partial exits are happening more frequently. The attitude of entrepreneurs has changed too. If you go back decades, founders would often hold onto a business until retirement age before selling it, whereas today you see more serial entrepreneurs who sometimes set up several businesses in their lifetime or entrepreneurs who grow with their business through rounds of investment, such as a Mark Zuckerberg.

The partial exit has become a very attractive middle ground for many entrepreneurs, but there are several things that they need to keep in mind before heading down that road. Many entrepreneurs may have advisors looking after their personal investments, who will always talk about risk management and a balanced portfolio. An entrepreneur’s business is often their biggest asset and most likely more significant in value than all other assets combined. Why not apply the same logic.

There are a number of scenarios when a partial exit might be right for a founder and their business. Perhaps the most obvious one is when there’s a desire or need to take a significant amount of cash out of the enterprise. In this case, the owner could be seeking to draw some liquidity from the business, but crucially, they may not be ready to end the journey and sell the whole business.

Another scenario that has become more common, is when the business that has reached such a size, that it has become the entrepreneur’s biggest asset, and they’re at the point where they worry more about the risks than the rewards and throttle back growth. There may be other personal drivers – selling a stake in the business can help an owner secure their personal finances or pay off their mortgage. In this scenario, they’re not looking to step away for good, they simply are seeking a level of financial security. They’re still committed to the business, believe in its future potential, and want to benefit from any future growth, so the idea of a partial exit presents a nice medium.

In other situations, entrepreneurs may be looking to grow aggressively and have an eye towards making acquisitions, so they’ll go out and find that acquisition funding, and as a part of a wider deal, going through a partial exit allows them to reduce the risk. In this case, it’s not about exiting, but more about de-risking while accelerating growth.

There are always tax considerations in play for fast-growth businesses, so it’s no surprise that founders will consider a partial exit to simply reduce tax liabilities. Extracting cash at capital value rather than dividends is more tax efficient, and more so if there is a potential for tax rates to change, as has been the case recently. This isn’t always straightforward though, so good tax advice is important.

The key thing to ensure before any partial exit is that the business is prepared, and in as strong a position as possible. There needs to be a coherent rationale for a partial exit deal, which is supported by the numbers. Presenting a clear, transparent picture of the business will reassure investors that the business is on solid footing and there is a strong business plan in place going forward.

With a partial exit, an investor is putting in a substantial amount of money, so in return they’ll want to see eventual returns. They’ll also want to understand how the business will grow, see projections and the plan of how the founder and their team will make that happen. It’s all about having a consistent story from start to finish that’s underpinned by numbers and a strategy that is ready to go. One that spells out things such as acquisitions, new product lines, or winning new customers.

Beyond that, it’s critical to get your house in order, from making sure all contracts are in place, to ensuring all taxes are filed. When Buzzacott is helping prepare a business for something like this, we prepare a catalogue of the financial history, so that it’s cohesive, and can be picked up by anyone who wants to review and understand the ins and outs of the company. The founder will want to ensure that there are no skeletons in the closet. But if there are any, our advice would be, don’t just hide them away, deal with them head on and any issues that they present.

The biggest thing to realise is that once a partial exit in a business is completed, it no longer fully belongs to them or the shareholders (if there are any). Private equity firms typically buy out part of the business and will be involved long term. As a founder, be prepared for disagreements arising in the future and that some decisions may be taken out of your hands. For some founders this poses no issue, but for others it can be a dealbreaker.

Many founders actually come out of this process stronger, but it’s still a significant risk, and a time-consuming process. Even with a professional advisor involved, it can take a lot of time and take a mental toll. The process can often take at least six months; even more when you factor in the prep involved. But while this is happening in the background, the founder needs to ensure that the operations of the business are running smoothly, to support future growth.

Confidence is important here. Any entrepreneur who starts the process needs to be fully committed to it, otherwise a lot of time is wasted with all the attention shifted away from the day-to-day running of the business. As with any kind of dealmaking in business, there are always risks involved, but if the all pros and cons are carefully considered before taking the first step, any entrepreneur embarking on a partial exit will likely find themselves in good standing as they move forward.

 

Working with founder-led, growth and exiting companies, Buzzacott’s corporate finance director Andy Hodgetts understands the perspective of an entrepreneur and strategically advises to help them generate and realise value in their business. 

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