How to Buy and Transition a Founder-Owned Business

Mergers and acquisitions (M&A)—specifically, those involving a founder-owned business—can be a very difficult process with many potential pitfalls and opportunities for both buyers and sellers. According to Harvard Business Review, approximately 80 percent of M&As fail, justifying the need for extensive collaboration and negotiation before business deals close.

Let’s discuss the intricacies of buying and selling founder-owned businesses, including some of the strategies one must employ, regardless of which side of the transaction one is on. From sources of capital and preclosure considerations to financing options and postclosure considerations, here is a powerful framework for successful mergers and acquisitions.

Sources of Capital

Before diving into the steps needed for successful M&As, it is important for business leaders to understand the sources of capital available to them. When referring to businesses in general, sources of capital can be categorized into internal and external sources. Here are some of the primary sources:

Internal Sources of Capital

• Revenue: The income generated from normal business operations and sales of goods and services. Retained earnings, which are profits reinvested in the business rather than distributed to shareholders, fall under this category.
• Cost Management: Efficient management of costs can free up capital. This includes reducing operating expenses, improving productivity, and optimizing supply chain management.
• Asset Sales: Selling off non-core or underperforming assets can generate capital for reinvestment in core business areas or other opportunities.

External Sources of Capital

Equity Financing

• Stock Issuance: Selling shares of the company to raise capital. This can be done through initial public offerings (IPOs) or secondary offerings.
• Private Equity: Raising capital from private equity firms or venture capitalists in exchange for ownership stakes in the company.

Debt Financing

• Bank Loans: Borrowing money from banks or financial institutions, typically with a fixed repayment schedule and interest rate.
• Bonds: Issuing corporate bonds to investors, which the company must repay with interest over a specified period.

Mergers and Acquisitions (M&A)

Mergers: Combining with another company can create synergies and access to new capital sources.

Acquisitions: Acquiring other companies can provide access to cash flows and assets.

Grants and Subsidies

Funding from government agencies or other organizations that does not need to be repaid. This is often available for specific purposes, such as research and development or sustainability initiatives.

Trade Credit

Delaying payments to suppliers to free up short-term capital. This is essentially an interest-free loan provided by suppliers.

Factoring and Invoice Discounting

Selling accounts receivable to a third party (factoring) or borrowing against them (invoice discounting) to access cash quickly.

Crowdfunding

Raising small amounts of capital from a large number of individuals, typically through online platforms.

In summary, sources of capital can be divided into one of the following categories:

• Internal Sources: Revenue, cost management, and asset sales.
• External Sources: Equity financing (stock issuance, private equity), debt financing (bank loans, bonds), M&A (mergers, acquisitions), grants and subsidies, trade credit, factoring and invoice discounting, and crowdfunding.

Preclosure Considerations

Buyers are in a very strong position in the M&A market, with an abundance of capital, up to $500M, ready to back privately owned businesses. Sellers should leverage their position to find a partner whose goals align with their own rather than just the highest bidder.

For buyers, standing out requires more than just capital. It is crucial to show unique value and establish trust with potential sellers by being honest, asking appropriate questions, and creating value.

Viewing these early negotiations like “dating” to ensure a mutually beneficial relationship can be valuable for buyers trying to acquire additional business entities. Both parties ought to exercise their due diligence to confidently align strategy and vision, setting up a successful partnership.

For a seller, there are several important steps one must take to ensure that they are getting a good deal:

1. Leverage a corporate attorney or certified exit-planning advisor. These professionals can do a thorough evaluation of your company and help business leaders understand the fairness of an offer.
2. Work closely with an investment banker (or a qualified and experienced business broker for smaller deals) to handle the negotiations. Sellers do not need to accept the first deal offered to them, and a banker can help business owners find the right fit and assist in the financial elements after the deal is closed.
3. Utilize a real estate planning attorney. This can minimize any end-of-deal surprises and help business owners receive deserved compensation for the value of their assets.
4. Consult with a wealth planner. They’ll help to ensure personal financial planning as well.

Structuring and Financing

When structuring and financing the sale of a business, there are four approaches to consider: cash, seller equity (or “roll”), debt, and earnouts. Each of these options has pros and cons, and both parties need to carefully consider which works best for their transaction.

1. Cash

For sellers nearing retirement and wanting a clean exit, cash transactions are straightforward and provide immediate liquidity. For buyers, however, cash-heavy transactions can limit flexibility and increase opportunity costs.

2. Seller Equity

When a seller wants to retain some level of ownership, seller equity is a potential structuring option. Leaders maintaining this ownership can help align the interests of both parties and foster long-term collaboration. Though oftentimes advantageous for the seller, this can result in reduced ownership for the buyer.

3. Debt Financing

Leveraging debt can be beneficial for the buyer, as it minimizes the initial cash needed to close a deal. However, it can increase the financial burden on the business after the acquisition because of debt repayment obligations.

4. Earnouts

Earnouts link part of the purchase price to the future performance of the business. While this can align incentives, it can lead to complex disputes between parties if performance targets are not being met and may require further deal restructuring.

In addition to these considerations, understanding the difference between an asset purchase and a stock purchase is crucial when making a deal. An asset purchase, often favored by buyers, involves acquiring specific assets and liabilities, offering tax benefits, and reducing exposure to previous liabilities. Conversely, a stock purchase is usually more favorable for sellers as it simplifies the transaction and may offer better tax treatment. The right mix of these two options depends on the goals of both the buyer and the seller, and they both must understand the terms of their agreement to make sure strategic objectives are aligned.

Postclosure Considerations

Shortly after buying or selling a business, ensuring that both parties are aligned on responsibilities and incentives is crucial for success. It is important to have open discussions about compensation, bonuses, control, and other factors before and after finalizing the deal.

One strategy to do this is using a framework like the RACI model (responsible, accountable, consulted, and informed). This framework can help eliminate any confusion about accountability or decision-making and establish clear expectations. Effective alignment on these fronts can facilitate smooth operations and pave the way for shared success.

This article features information from the speakers and presenters at the 2023 Ampleo CFO & Growth Summit.