would . It also saddles the company with debt — a loan that must be repaid — adding leverage to the balance sheet and perhaps even affecting the company ’ s creditworthiness . And the departing founder or majority shareholder has to provide a guaranty for the loan repayment .
The debt service for this structure , meanwhile , diverts cash that could be used for the company ’ s annual dividends or growth initiatives , and if the loans are variable , that could later increase debt costs .
Private Equity Partners
The second strategy for exiting founders / CEOs is to turn to outside investment from a private equity firm , which entails issuing a new class of preferred equity for these third-party partners . The structure usually involves selling a minority or majority stake , and in return the company gets both growth capital and partial liquidity for the company founders .
The pros of this scheme include an influx of capital that , unlike the loans , doesn ’ t require repayment . The partial liquidity companies get from this strategy also allows the founders to take “ chips off the table .” Meanwhile , the equity they hold onto can be sold later — often at a higher valuation — which offers them a second bite at the apple .
Beyond those advantages , the companies will now also benefit from the expertise and resources that private equity firms offer , including their valuable advice , industry connections and financing for acquisitions and growth . PE firms typically prioritize a company ’ s growth , which will likely align with the founders ’ goals for expanding .
Yet this approach , too , has disadvantages . The private equity firm is going to require that preferred returns be paid to investors , which can be similar to loan interest . The equity that ’ s retained will be diluted , though the investors with the retained equity will share future upside .
Another disadvantage is that the company ’ s founders and original shareholders lose total operational control . The new investors may impose significant reporting requirements and board representation , which can sway company decisions .
Private equity firms also have their own exit agenda — they ’ re aiming for a return on investment within a specific time frame , often leading to pressure to sell or achieve liquidity within their secondary investment period . And if the company ’ s performance falters , the private equity partner might demand management changes to protect its investment .
Company Sale
The last strategy is the outright sale of the company to a third party , either through an equity or asset sale . This approach allows someone who ’ s built a business to unlock its full liquidity and gives them an immediate and complete financial exit . In this case , the interests of the buyers and shareholders are aligned , since they hold the same equity class . There ’ s no need to pay preferred returns .
A strategic buyer would often improve on the company ’ s capabilities , offering it economies of scale , revenue growth and cost reduction .
On the downside , these deals often come with earn-out requirements , where certain financial or operations targets must be met by the company after the transaction for the seller to get the higher price .
The reporting and control requirements are also going to change , and the buyer ’ s representation on the board will limit the autonomy of shareholders or founders who remain at the company . These changes will also likely lead to cultural shifts , especially if the buyer ’ s decisions differ from the founders ’ vision , and that can be an emotional transition . Buyers might lay off redundant employees , which would further affect the company ’ s culture and morale .
On top of these disadvantages are the founders ’ indemnity obligations , where they must provide representations , warranties and indemnities as part of the purchase agreement .
The Right Choice
Departing founders and CEOs have to weigh these pros and cons against their personal goals , the company ’ s performance and market conditions . Dividend recapitalization will let them perhaps keep control of their company and win them some modest liquidity , while a private equity investment would give them growth capital and partial liquidity with investor support . If they sold the company outright , it would ensure they get full liquidity and operational synergies , though it would involve significant transition challenges .
By understanding these strategies , the founder / CEO can make an informed decision that aligns with their long-term vision and ensures a successful transition for their company . While understanding the primary exit strategies is a good baseline , it is best to engage the right legal advisor to choose the optimal path .
ANDREW APFELBERG , a partner at Greenberg Glusker LLP , is a corporate and finance attorney for middle-market companies throughout the United States .
OCTOBER 2024 | FINANCIAL ADVISOR MAGAZINE | 31