For a business owner whose company might be attractive to partial-interest investors, this article addresses two important questions:
- Why would I want to sell part of my business to an investor?
- What should I look out for?
But first, let’s define our terms.
While partial-interest transactions can take on many forms – e.g., divestitures, spin-offs, joint ventures – this article will focus on the most common situation, in which a business owner sells a minority or majority interest in their company to an investor, in exchange for capital and other considerations, while retaining an agreed measure of ownership and control.
As we have noted in other articles, 70% of the buyers in overall deals facilitated by IBG Business are “financial” buyers – i.e., private equity groups and family offices – looking for businesses that will generate high returns for their investors. In sales of partial interests, that percentage is substantially greater, bringing to a potential purchase a higher degree of sophistication and predictability.
“Why would I want to sell a share of my business?”
Depending on what you want and where you are in your career and life, the potential benefits of bringing on an investor can be substantial:
- The infusion of investor capital can help your business reach the “next level” by seizing growth opportunities (e.g., product development and expansion into new markets and verticals), replacing debt, pursuing strategic acquisitions, and seizing other opportunities to fulfill its profit and potential market value.
- Partnering with an investor that knows your industry and type of business allows your company to tap into their financial and business connections, operational know-how, technological resources, economies of scale, and strategic insight, and expose your business to new opportunities that would otherwise have eluded you.
- In addition to professionalizing your operations, your best-fit investor can lighten your administrative burden and free you to focus on production, sales, and growth.
- Sharing the risks of business ownership with a vetted investor reduces your legal and financial exposure.
- Bringing on an investor can be your first step in a profitable exit strategy that starts with you continuing in your position of control and concludes with a negotiated buy-out of your interest, a smooth ownership transition, and, potentially, a continuing strategic role – all as a reflection of your overall desires and priorities.
- If your investor is adept at achieving
industry roll-ups, selling a partial interest to them now will offer you a second bite at the apple when your business is ultimately “rolled up” in a multi-company sale.
- The sale of a partial interest can create a path to equity, and an incentive to stay on, for your current management team.
Successful Deal. Our recent sale of a majority stake in a storm infrastructure maintenance business illustrates the common benefits of partial-interest transactions.
The energetic, passionate owner was looking for the best-fit buyer to help him grow the company, strengthen its mid-level management, and bring in a board of directors for strategic guidance. IBG Fox & Fin’s Troy Stapley, who facilitated the transaction, recalls the progression of events.
“When the company was just getting off the ground, I told the owner, ‘When you hit half a million in EBITDA, let’s talk.’ Before long, he had more than doubled that amount and was totally overwhelmed with running the business. It was time to bring in that best-fit investor.
“We found a group that had purchased a company just like his,” said Stapley. “They had scaled it, sold it, and made a ton of money and were looking to do it again. They knew the industry, they knew the ins and outs of how to help grow his business, he and they hit it off, and it’s been a huge success story. Today they’re looking to exit out of it, way ahead of schedule.”
“What should I
look out for?”
As with a conventional business sale, a partial-interest sale is most likely to reach a successful closing and maximize the benefits to the owner if the owner relies on an experienced M&A advisor.
In addition to identifying best-fit investor candidates, scrutinizing their experience and success histories, and evaluating owner/investor compatibility and philosophical alignment, the M&A professionals at IBG Business can help you analyze the potential impact on your control and decision-making power within the company, and identify and help negotiate the issues that are peculiar to the sale of a minority or majority interest.
Those issues, which must be thoroughly addressed in the purchase-and-sale agreement, include the following:
- the percentage of ownership being sold;
- the value of the ownership interest being conveyed (see “valuation discounts” below);
- governance structure (allocation of decision-making powers between the board of directors and the owner);
- voting rights of each party;
- operational control (even if you retain a majority stake, your decision-making power may be diluted);
- strategic control;
- profit distribution (how much, how often, etc.);
- restrictions on selling shares (by both parties);
- liquidity requirements;
- scope of fiduciary duty;
- confidentiality, post-closing (restrictions on what information can be shared by either party, with whom it can be shared, and under what circumstances);
- conflicts of interest (could an investor in your company also be an investor in a competitor?); and
- procedures for dispute resolution.
Valuation Discounts. If your business is valued at, for example, $10 million, and you and the investor agree to the sale of a 40% stake, be prepared to receive less than the expected $4 million.
The culprit: DLOM, or “discounts for lack of marketability.” As
Investopedia describes, DLOM refers to a business valuation method by which the value of a partial ownership interest is discounted – sometimes substantially – because, as in the above example, the stake represents less than 50% ownership (presumably with little control), can be sold only if restrictions are satisfied, and is subject to liquidity conditions.
If an owner is willing to sell a majority stake, that will help reduce, but probably not eliminate, the DLOM impact.
Why DLOM Might Not Matter. DLOM would be a major issue in deals where the investor says, “We want to buy X percent of your company, under the following terms, and we’re willing pay Y dollars for it.”
But in our experience, the negotiations almost never begin that way. Instead, we facilitate a discussion between the owner and potential investor to determine:
- the business’s potential value if certain improvements are achieved;
- how much investment capital the business will need to achieve those improvements; and
- what ownership percentage the investor requires in order to justify that level of investment.
Once those variables are nailed down, the informed investor will come in with an offer. “We think that we can increase the value of your business to X dollars. That will require us to invest Y dollars, and in return we will need to own Z percent of the company.”
What We Bring to the Table
As Troy Stapley notes, “Part of our job as M&A intermediaries is to find the right-fit buyer – someone that might provide more operational experience, maybe bring in their own team. Maybe it’s less that and more of just financial resources. Maybe it’s a combination of the two. At the same time, we work hard to honor the owner’s goals and needs, so that in the end everyone – the business, the investor, and the owner – comes out ahead.”
Over our long history, IBG Business’s 1,200-plus deals – including a sizeable number of successful partial-interest sales – have an 86% closing rate, more than three times the national average for our profession. To start the process of preparing your business for a successful sale, contact any member of the
IBG Fox & Fin team of dealmakers.
