M&A Transactions: Sell a Piece of the Company

Business owners don’t need to sell the whole business and then retire or move on to other pursuits. A substantial amount of M&A work is done with sellers who just want to sell a part of the company. There are a number of reasons a business owner may want to sell a piece of the company.

Need capital for growth

A growing company often needs more cash than it can generate from operations. If the owner doesn’t want to put her own money into the company or sign a personal guarantee for a bank loan, she can raise money from an outside investor. Outside investors come in two basic flavors, control and non-control:

  • Control investment: A control investment simply means the investor has control of the company. This situation occurs when an investor, often a venture capital or private equity fund, invests money in exchange for stock in the company.

    In most cases, this investment is in the form of a majority equity investment — that is, the new investor owns more than 50 percent of the equity in the company, or the bylaws of the entity are amended to grant effective control to the investor.

  • Non-control investment: A non-control investment, often called a minority equity investment, is similar to a control investment, except the investor doesn’t have control of the company.

As you may guess, Sellers tend to prefer the non-control investments, while Buyers prefer control investments. The control investor has greater recourse to change management and affect the direction of the company. The non-control investor simply goes along for the ride, with little or no recourse to exit the investment.

Diversify assets

Many business owners have nearly all their wealth tied up in their companies, so their finances are in serious jeopardy if the company fails. Selling a piece of the company to an investor allows an owner to create liquidity in an otherwise illiquid holding. This maneuver is called a recap (short for recapitalization).

With the right investor, an owner who has recapped her business also has a capital source for further investment in the business and/or for acquisitions. In other words, the investor may also be willing to pony up more money to invest in the business or pay for acquisitions.

One of the many challenges for most business owners is the age-old question, “Do I pay myself a big fat dividend or reinvest that dough back in the company?” By selling off a piece of the company, the owner is essentially able to pay herself that big fat dividend and have a source of capital for growth.

Lastly, a recap sets up the owner to get a “second bite of the apple,” that is to say, to generate a second liquidity event (realizing a gain from an investment by selling shares for cash) when the company is sold to another acquirer.

For an owner who’s looking to retire in five to ten years, the recap can be a great way to lock in a certain amount of wealth and allow herself some additional time to continue to run and grow the company, setting up a potential second payday when she sells off her remaining shares and retires or goes off to another venture.

Bring in an outside investor to buy out a partner

Partners are a great way to build a business: One person deals with one area, such as sales, and the other handles another (say, the back-office administration and accounting). That’s a good coupling. The downside to having partners is that they sometimes stop seeing eye to eye, and one of them needs to leave the business.

For a closely held business, this situation can be a problem; the partner who wants to stay may not have the money to buy out the partner who wants to leave. Bringing in an outside investor is a way to solve this problem.

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