Episode 073: Strategies for a Successful Business Exit

(00:00:00) Commentators: You’re listening to The Wrap, a Warren Averett podcast for business leaders designed to help you access vital business information and trends when you need it. So, you can listen, learn, and then get on with your day. Now, let’s get down to business.

(00:00:17) Kim Hartsock: Hello everybody, and welcome back to another episode of The Wrap. We are here today for episode 73, continuing our new season called the Business Life Cycle. Today, I have a guest host with me, Chris Branch. Welcome, Chris, to hosting the podcast.

(00:00:37) Chris Branch: Thanks, Kim. As Kim mentioned, my name is Chris Branch. I work in our Birmingham office with our Tax and Advisory Group. I’ve been here nine years, and I look forward to getting to a decade here in the next 365 days. I primarily work with our construction and real estate clients, but that doesn’t mean I don’t dabble in a lot of other areas as well. All that being said, I’ve been here a long time and I’m looking forward to talking with Kim and Hanny today.

(00:01:04) Kim Hartsock: We’re glad to have you, and I look forward to our discussion. To continue our discussion on the business life cycle, we’ve covered the startup phase, moved into the growth phase, then into maturity, and today we’re talking about exit transition, which is a really exciting stage of the life cycle. We have our in-house expert on all things exit, and that is our Member, Hanny Akl. Hanny, welcome back to the podcast.

(00:01:33) Hanny Akl: Thank you. Thank you for having me.

(00:01:35) Kim Hartsock: Do you want to reintroduce yourself to the listeners who may not have listened to you before?

(00:01:40) Hanny Akl: Sure, absolutely. It’s been a little while. As Kim said, I lead our Transaction Advisory Practice. I think it’s important to step back a little bit and walk through my career for a second. I started here in Birmingham at a Big Four firm for a few years and then came over to Warren Averett at the Manager level. At that time, I was still working in Audit but gained a lot of experience in various businesses: small and large, public and private. I worked with all types of businesses, from manufacturing to government contractors to technology and service businesses. It was really great experience throughout.

A few years later, I had an opportunity to leave the firm and run a small business here in Birmingham, which I did for a couple of years. I positioned it for exit and completed a transaction. At that time, I came back to Warren Averett and started what is today the M&A Practice. Hopefully, I can provide some insights since I’ve been on both sides of the table and add value to the audience today.

(00:02:36) Kim Hartsock: Yeah, I’m looking forward to it. When we think about the exit phase of a business, it can mean a lot of different things. How would you describe what the exit phase is and how does it fit into the business life cycle?

(00:02:50) Hanny Akl: Yeah, that’s a really good question. Exit can mean a lot of things and we’ll talk about exit options in a little bit. When I say the word “exit,” it doesn’t just mean an outright sale. We’re talking about several different things, from recaps to small minority sales to an outright sale. Let’s keep that in mind as we walk through this podcast. It’s interesting to think about that it may not be so much the actual exit as it is the timing of the exit. Kim, you and I are always talking about helping clients plan for an exit from the start of a business. So, if you’re starting a business tomorrow, the key strategic initiative should be: what does the exit look like at that moment? This may be five years from today, it may be 10 or 20. But let’s start talking about that from the beginning. If you are doing that, it’s not so much about what the exit is, because you’re planning for that regardless, it’s really more about the timing of the exit and when.

(00:03:53) Chris Branch: Hanny, that’s a great point. You talk about planning for the exit from the very beginning. But going a little bit more into the actual exit, what are some triggers that bring about beginning to really start that exit and transition into the next phase of the business?

(00:04:11) Hanny Akl: Yeah. It’s a magic question: when do I exit? There is no right or wrong answer. We may talk about seller’s and buyer’s remorse later, but this is a good moment to remind people that seller’s remorse is real, and we see it throughout a transaction. It’s important to try to keep emotions out as much as possible. There are natural causes to when you should exit. Age is probably the number one thing. It doesn’t mean you’re 80 years old, and that means you have to exit. We have plenty of business owners who are 80 and 85 years old, running their businesses and doing well. They’re not thinking about exit today, in terms of what we consider exit. Then there are 45 and 50-year-olds at a moment in time where they need to.

They may be thinking about an exit for other reasons; maybe it’s a career shift. That’s important to consider. “Hey, I’ve been doing this for a long time. Maybe my family owned this business for a while and I’m third generation. I’m 45, and I think I want to pivot into something else.” We see that. We see grandchildren coming along, children coming along. I hate to go down a negative path, but divorce, cancer and medical reasons really do force people’s hands into an exit. Those are some reasons that come along. Sometimes the business outgrows you and that’s okay as well. Running a $5 million and $10 million business is one thing and running a $100 million business is another. Sometimes you just don’t have the skillset for that and that’s okay. It’s time to bring on a partner at that moment.

Last but not least, we’re seeing a lot of this these days, but distress. If a business is in distress, that puts you in a situation where you need to bring on a partner or do an outright sale. We are seeing a little bit more of that uptick these days. Just something that I was going to throw out, in the last 12 months, we’ve had several situations where business owners were looking to sell their businesses or had unsolicited offers two, three years ago in the height of Corona and after. They didn’t take the offers and now, fast forward to today, they’re being forced to sell for various reasons. Some of the reasons we just described, some are good, some are bad and they’re not getting the same offers they were before. So that’s something to think about.

Two specific examples: a couple of years ago, we had a salt of the earth business—a small business—but they had an unsolicited offer from a strategic—basically a business in the same business as theirs—offered $5 million for that business. The business owner wasn’t in a position to sell at the time, even though their runway was running out. It was time for them to sell, but they didn’t think the offer was quite where they wanted it to be. So, they didn’t take it. Fast forward two years to this moment.

Now, they’re ready to sell and go back to that same offer. Those guys aren’t even on the table. They went to a couple of others and they’re getting about half the price of what they were before, between $2 and $3 million. It’s hard to get that number out of your head. We had $5 million before. Why am I not getting that now? The business is still the same, if not better today than it was then. There are market conditions and other things that play into that, but unfortunately, they’re just not going to get there. They have to make a decision. Is this enough for them to retire on? They’re an older couple: is this enough for them to retire on? Can they get their heads wrapped around half the valuation at this point? We have another manufacturing business, and several businesses did really well coming out of Corona. Others didn’t do well, but several did really well. These guys got an unsolicited offer. This business was doing probably 10 times what they were before Corona. They got an unsolicited offer that was more than this business would have ever been worth. The business owner thought, you know what? We’re riding this wave. I’m going to continue to ride it. I’m going to hold on to this business for a little while. Why would I sell post-tax? Here’s what I’m going to get. Why would I sell now? I could make that up in two, three or four years. Unfortunately, the foresight wasn’t there. The business is starting to dry up and go back to what we would consider normal.

Now, those offers aren’t anywhere near what they were before. You can kick yourself in situations like that. There are plenty of positive examples as well, but those are two that resonate right now, in front of us, that we look back and say hindsight’s 20/20. You probably should have taken it then. The only thing I’ll tell our audience here is to weigh all the facts and circumstances at the time and make the best possible decision you can. Try to hire folks around you to help you answer those questions the best you can, and then make the best decision you can at that moment.

(00:08:37) Kim Hartsock: Hanny, you just outlined several ways someone can enter the exit phase and a variety of reasons, but there are some overlapping characteristics of this phase and also challenges. Can you share those with us?

(00:08:51) Hanny Akl: Yeah, absolutely. Maybe this is the best moment to talk through the options that are out there. Let’s put those out there really quick. We could have a whole podcast on exit options in and of themselves. We do sit down with our clients. I spend a lot of time with our clients who are just saying, “Hey, I don’t know what exit looks like.” Next year or in a few years, we’ll sit down for an hour or two, walk through these things and educate them on what’s there so they can think about this later on. I’m going to hit the seven or eight items really quick, just so we can make sure the group knows what we’re talking about when we say exit. We do have these in a slide deck, and we’ll have those uploaded to our website if you want to grab those.

(00:09:31) Kim Hartsock: We’ll link to those in our show notes. If you’re listening to the podcast, just look down in the show notes, and we’ll put a link there.

(00:09:38) Hanny Akl: Real quick, intergenerational transfers are exactly what you would think about, family transitions, maybe to kids or others. These are low costs and the least disruptive type of exit option here, but there are family dynamics, and the sales price is usually a little bit lower than some of the other options. Second, management buyouts: this is where managers are trying to buy the business off of the business owner. Again, you have continuity of the business, highly motivated buyers, so that’s good. But usually, the sales price is a little bit lower, but you also have to be careful with this option. Sometimes the managers may sandbag the business or hold you hostage if the deal isn’t going the way they want, they may threaten to leave or whatever. It doesn’t always go well in that case, so be very careful when you’re walking down a management buyout path.

Partner buyouts, of course, that’s a very planned and controlled process. But again, there could be potential discord between the partners. The sales price is usually a little bit lower than some of the other options.

An ESOP—employee stock ownership program—this is where you may get the highest sales price, but it’s very expensive to do and highly complicated. It doesn’t always fit; it doesn’t fit most situations. Sell to a third party, which we’re always talking about. Everybody knows and loves this. This may yield a little bit higher sales price, maybe provide you a way to walk away fairly cleanly over a year or two. But these are very hard and very emotional, and most people don’t realize that these are very hard to close. We’ll talk a little bit about those things as we go along. Recapitalization of the business. So, dividend recap, minority recap, this is where you’re bringing on a partner. Maybe you get a second bite of the apple later on as the business grows, but you also lose control of the business. The culture shift is a real thing, so you have to worry about that. One option most people don’t talk about but is an option—liquidation. Shut your door, sell your assets and call it a day. Those are the options. As we think about characteristics, it’s really about how much runway a business has. Where are you in the business life cycle? But the common denominator of all of these options, especially to yield the highest valuation and the best possible transaction, is a growth story. Most people skip over that particular point, but I will say that when you have a really good growth story, the business over the last two, three, four or five years has been growing. And again, it’s not because of a Corona pop or anything unnatural. It’s more about the business just doing well, whether it’s through M&A or other organic factors.

The growth story is really important to getting the best possible transaction you can. So, I think that’s something to really think about as we work our way through value drivers, or let’s just think about detractors of value. I’ll put it in terms of what detracts value. You can always flip it to the opposite side and look on the positive side. I’ll mention a few things that we see more often than not. Concentrations: customer vendor concentrations, heavy competition, no secret sauce. It’s more of a commodity business. Maybe it’s discretionary spending rather than mission-critical spending. Lack of recurring revenue or predictable revenues, low-margin business, potentially lack of leadership, lack of talent within the business and quite frankly, high turnover. Maybe there’s a situation where you have a lot of employees who are starting to exit from your business. That doesn’t always bode well. Those things will detract value from the business.

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(00:13:15) Hanny Akl: If we want to think about after we’ve put together a transaction, valued the business, and now we’re thinking about what we call deal killers. This is a little bit different than what you would consider value drivers. These will derail the deal. I thought through our last 10 or so transactions, and what were the common themes we saw that broke down those transactions? It boiled down to these few issues: messy books and records, so your financial statements just aren’t in good shape. They’re hard to explain, hard to put together, so that causes all kinds of problems. We talked about flat or declining revenue or profit, so not having the right growth story. The trends are telling a different story than what you’re telling folks about where the opportunities are in the business. We have all kinds of problems when it comes to, for instance, sales tax. We’re in the middle of a deal right now. We had this conversation with the client and the target yesterday, but they weren’t filing taxes in a particular state. It’s a technology business. They didn’t realize they needed to file in this state because that particular state had some special rules around it. When we did our calculations and ran through all the numbers, it’s a $200,000 impact on the business or a liability to the transaction.

As our client is looking at this thing and trying to figure out how to make this work for this particular business owner, it’s a distressed deal. He was already going to walk away with very little cash. When you factor that in, he’s actually going to come out of pocket to do this deal. That’s a problem. Now our client is trying to figure out an earn-out scenario where he can put money in his pocket later on. This is one of those things where that falls on the seller. These issues are obviously the seller’s problem. Those get pushed to his side of the balance sheet and his side of the transaction document, and they have to figure out how to shore this up. I don’t have an answer on where we’re going to go with that one, but it is a real problem. Structure of the deal is important: stock versus asset deals and everything that goes with that. Legal issues are another thing we’re encountering a lot: undocumented arrangements, undocumented contracts. Lawsuits—those are a big deal. There’s exposure there. Unreasonable expectations from the business owner. That also seems to come up a lot and is causing deals to fall apart. Maybe the transition period isn’t quite right. Cash at close isn’t quite where they want it. The valuation, of course, is always a big deal, and there’s some disparity there. Then there are a bunch of personal and unusual expenses that work their way through the business. You have to be really careful with those.

The most notable example I have—and I’m smiling because this is one of those situations you would never expect— but we were diligencing a CPA firm. This business did about $5 million in EBITDA. So, a good-sized business, but more than half of that EBITDA was personal expenses. As we were working through this thing, peeling back the onion, we found he had his neighbor on payroll, his neighbor’s mortgage on the books, extravagant travel, every child on payroll, which we see often, and just all kinds of things. You can’t even imagine the things we were seeing in this case. But as we thought about it, we’re looking at it and saying, “Man, this guy’s throwing in like $3 million worth of addbacks that are all personal.” He’s a CPA. You all know this well, Kim and Chris; we are under a code of ethics. As we started talking to our client about, “Hey, this is problematic, not because these things are unusual—we get it, you run personal expenses through—but this guy’s a CPA and he’s running a firm. You’re going to need this person to run the firm going forward. He has to sign off on these audits, tax returns, you name it. What if he’s pushing these things through for his own clients? That puts you at some extreme risk, going back to the legal risk here.”

(00:17:08) Kim Hartsock: An integrity issue there.

(00:17:10) Hanny Akl: Oh my gosh, it was ridiculous. So, our client took our advice, walked back through that, thought through all the other things they were noticing, and walked away from the deal. We were towards the end of this thing, but we were towards the end, and they walked away. These deal killers, as I’m calling them, they are real. I don’t want the audience to think we don’t get deals done, right? We do deals; we do get to close. That’s our job. There are plenty of positive and negative stories that we have to go through to frame out where transactions are.

And Chris, you said this earlier: every deal is different. So, it’s really hard to frame out a generic answer to the question you asked, but hopefully, this gives the audience at least a few things to think about.

(00:17:56) Chris Branch: Hanny, we’ve talked a lot about the seller side today. Talk a little bit about evaluating your buyer because I know a lot of sellers are thinking about the dollar figures they will get walking away from the deal, but I’m sure many people want to ensure that the buyer will be able to fulfill that.

As well as the fact that the buyer will come in and treat their business the same way they treated it.

(00:18:19) Hanny Akl: Yeah, that’s a great question. Most sellers don’t believe they can ask questions and do what we would consider reverse diligence. In this case, we would absolutely advise you to ask questions before you share anything. Don’t even bother answering any of their questions. Instantly flip to why did you come to me? And so, there are a few questions that you can ask these folks. So, I’ll pepper through those really quick and then we’ll back up and frame this out a little more generally.

How did you find us? Why are you interested in our business? What experience do you have in businesses like ours? What are your plans for us if we move forward? What deal do you have in mind? Let’s start talking about the structure of the deal. How are you going to finance this arrangement?

I’m going to touch on that in a little bit. But what other deals have you done? Let’s talk through what experience you have in this particular space. So, asking these questions, not sharing any information, but just walking through these, asking them to come down and visit with you.

That’s always a telling moment: are you willing to fly to me wherever you happen to be, and let’s just sit down and talk through this? I think it is a good way to start. I will say—and you would expect me to say this—hiring an advisor at this moment is good. If you are entertaining the idea of a transaction and you get some answers to these questions and feel like it’s moving in the right direction… definitely hiring an advisor, whether it’s an attorney, accountant or investment bankers, where we would lean…I think that’s really important.

Now I think this is as good a moment as any to throw out the market today—Corona lended itself to many folks choosing to want to own their own business and get out and try to find a business to purchase instead of starting from scratch. And so, there are—and I don’t want to make this sound bad—but there are a lot of posers—air quotes—out there.

We do work with many great groups, and there are single-shingle folks out there that are fantastic and are looking for the right type of business for themselves. There are larger groups that you would consider private equity or family offices—or even independent sponsors—that are good groups.

So don’t get me wrong; there are plenty of folks out there who can do a transaction and should do a transaction. However, many folks came out of Corona looking for businesses that don’t have the wherewithal to do the transaction.

You have to be very careful. They don’t have the experience, or they don’t have the knowledge of that particular industry. They don’t have the financing to get it done. It is important to ask these questions and then ask for proof. Just work your way through those questions and make sure you do some reverse diligence.

The only other thing I’ll mention is that every transaction is not always about price. So don’t focus so much on the overall purchase price as it is on the overall structure of the transaction.

(00:21:09) Kim Hartsock: A lot of times, especially the businesses that we work with are closely held family businesses.

And with that come some dynamics of emotions and challenges of working with your family, and one wanting to exit and the other not. So how do you work through that? And how would you advise business owners who are in that type of business setting to navigate this process while knowing that they’re dealing with all these other challenges?

(00:21:40) Hanny Akl: Oh, yeah. Yeah. We talked about remorse earlier, but if you’ve ever sold a car or a family house that you grew up in, you feel it. So, imagine selling a business, especially one that you’ve been in for a long time, or let’s just take it one step further. Let’s say it’s a third-generation business.

The emotions that come with that are insane. What’s grandfather or grandmother going to think—our late grandmother, grandfather going to think—if I sell this? But you have to take the emotion out immediately. I know it’s easier said than done, but you have to try to take that emotion out and focus on the facts and circumstances in front of you.

I will say, and I’ve said this a couple of times already, hiring an advisor at this moment is your best bet because they will help you take the emotions out, focus on what’s important and then work through those things. There is no script to a transaction. As much as it feels like there is one, there isn’t.

So working through the steps and all of the things that are happening are important. I don’t think you or I are in a position to do that as a business owner. You’re not in a position to do that. Somebody objectively coming in is going to be your best bet.

(00:22:49) Chris Branch: Hanny, you talk a lot about the dynamics of a family business and stripping the emotion out.

Are there things that you’ve seen in transactions that help create a longer-lasting legacy within that business, even if the family is coming out?

(00:23:04) Hanny Akl: Yeah, I think advice I got a long time ago resonates here and, in a transition, to working yourself out of a job. I think business owners—and it’s interesting, we get into these conversations all the time—business owners believe that they are adding value by doing more.

Unfortunately, it’s actually a detractor of value. If we walk into a transaction and find the business owner has their hand in every pot and their relationships and employees are loyal to them and everything flows through their office, that’s a problem. That can be considered a detractor of value—going back to what we talked about before.

It can be considered a deal killer. It falls into both buckets, if you will. So, you have to be careful. But as it relates to your legacy and all of those things, that’s how you create the legacy: creating processes, procedures, hiring the right people for the right seats and delegating all of your responsibilities.

By the time you get to a transition transaction, I don’t want to say the business owner is irrelevant, but they are at a moment where the business will carry on with or without them. Take that one step further: you can exit on your own terms at that point because you’re not in the business where some of the natural things we talked about, whether it’s age or a bucket list or whatever it happens to be, you’re able to do those things even while owning this business.

So now you’re exiting on your own terms.

(00:24:26) Kim Hartsock: Hanny, this has been a really good discussion, and we could probably continue this on for another hour, but we always try to wrap this thing up in 60 seconds or less. So, what is your ultimate piece of advice for entrepreneurs when they are thinking about the exit stage?

(00:24:43) Hanny Akl: Yeah, it’s hard to wrap up something like this, like you said, in just a minute, but I will say picking the right partner is probably one of the best things you could do. I don’t want people to lose sight of the fact that there are good groups out there. I think as you are entering the transition or exit phase, finding the right group to come in and take over the business is probably the number one thing.

Don’t be afraid of an exit. Don’t wait too long for an exit. Always be talking about an exit. Let’s round out what we started the conversation with: you should always be thinking about it. It’s healthy to do that. Surround yourself with advisors as well, throughout the process, not just in the transaction, but before—whether it’s a year or two or five or 10 years before.

Surround yourself with folks who have their eyes on the market. So, folks like ourselves, legal investment bankers, we know where the market’s headed. So just keeping your eye on those things as you progress through the business and then get into an exit phase is really important.

(00:25:38) Kim Hartsock: This has been great, Hanny. Thanks for joining us again. And Chris, thanks for joining us as the co-host.

(00:25:44) Chris Branch: Yeah. Thanks, Kim.

(00:25:46) Kim Hartsock: Thanks, everyone.

(00:25:46) Chris Branch: Thanks for having me.

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