In every internal transfer, whether to family or employees, the owner/seller has to make the harvest or grow decision.
We’ll presume that your business has already reached a point where its value meets or exceeds your financial objectives as the owner. If growth is required in order for you to afford your next act, then that decision is less strategic than it is driven by your lifestyle requirements.
If the company has already reached a substantial level of success, however, you may still be tempted to maximize cash flow until your departure. Deliberately reducing your cash flow by starting a process of equity transfer may not sound very appealing. The obvious question is “Why would I sacrifice my personal income in order to finance their acquisition of my company?”
Why not harvest?
The answer to that question revolves around the strength of your desire to control the process. Although staged internal transfers of equity almost inevitably require that the owners surrender some personal income at the outset, there is considerable psychological value in dictating the timing, method, and eventual proceeds of your exit.
When compared to the listing and sale process of presenting the company to third-party buyers, an internal transfer allows the maximum of owner control. There is no exposing the finances of the company to strangers. It doesn’t require negotiating, sometimes against professional negotiators, or against low-bid opening offers. Since internal buyers are already familiar with the organization, it can circumvent the often excruciating process of due diligence.
IAs a seller, you can look at your up-front funding of initial equity purchases as a sort of insurance policy. No lender will fund 100% of an employee purchase, and family purchases are rarely financeable. Transferring equity to the buyers, whether it is fully paid for or via a subordinated note, allows them to finance the balance of the purchase.
The “insurance” factor is usually understood. In return for sacrificing some cash flow now, an owner can leave on a chosen departure date with 70% or more of the proceeds in hand. The longer you wait, the higher the probability that you will have to owner-finance the entire transaction.
Why not grow?
There are also a few arguments against a growth strategy. The chief one among these is time. If you are pressed for time due to the influence of one of the Dismal Ds, then you may not have the three to five years that it typically takes to build the buyer’s equity to a point with the balance of the purchases financeable.
This essentially leaves you as the seller with two options. Either you can take the risk of financing the transaction yourself or place the company with an intermediary for a third-party sale.
If the buyer is a family member or members, it may be more advantageous to transfer the company via estate planning. Then you are usually limited to drawing such income as the company’s cash flow can support until you pass away.
Of course, these issues are influenced by both your lifestyle goals and legacy intentions. In the absence of outside forces creating time constraints, however, the decision not to grow is seldom favorable for either the seller or the buyers.
Harvest or grow?
There are several factors that strongly favor the decision to grow throughout a transition process.
Overall, business organizations act much like organic entities. They are either growing or dying. Trying to merely “hold the line” against the normal forces of changing markets and competition can be challenging.
Growth provides opportunity. For a seller, the growth in the value of the company may be pushing it towards your retirement goal or simply enhancing your lifestyle options. For the buyers, equity purchased in installments is increasing in value over the course of the transition. They are seeing a tangible benefit for their contribution to the growth.
The transition plan may also build in growth as a prerequisite for any equity purchases. This has the effect of gradually transferring the responsibility for the organization’s success from the seller to the buyers. As they become more invested in the success of the company, the burden of leadership lessons for the exiting owner.
Many owners consider the decision to exit as “the beginning of the end” of their entrepreneurial career. That is a mistake. As advisers, our job is often to help the owners see their exit plan as the beginning of a triumphant capstone to their successful business careers. The decision to harvest or grow is really one between going gently into that good night or kicking off the next act of their lives with a bang.
