Outlined here are  key considerations for family enterprises looking to pull out of direct investments via a stock sale, asset sale or merger, or what he describes as an “exit sale.”

Direct investing by family enterprises – families, family offices, and family-controlled investment vehicles – has been increasing for several years. These family enterprises have emerged as competitors to venture capital funds, private equity funds and hedge funds, particularly for investments in the middle-market.

With the US economy beginning to pick up steam, many experts expect the pace of M&A activity, which has been slow the past five years, to quicken. If this is indeed the case, family enterprise investors who made their initial direct investments during the past few years may finally be looking at the opportunity to realize upon these investments.

Exits, or liquidity events, come in several forms - stocks sales, asset sales, mergers, refinancings and public offerings, to name a few; some of these events result in a complete exit from the investment, while others provide partial liquidity. While these various structures share several characteristics, this discussion will focus on a complete exit from an investment, via a stock sale, asset sale or merger – an “exit sale,” if you will.

Exit sales sound easy. You’ve invested in a company, nourished it, and seen it grow, and you’ve now identified the perfect buyer - likely a company in a related business - which is looking to acquire 100 per cent of the stock of your portfolio company, for cash.

If only it were that simple. Especially for the family enterprise investor, exit sales require planning, planning, and more planning.

Considerations

Of course, much of the planning relating to an exit sale should ideally be done at the time the investment is made in the structuring of the investment vehicle, the investment security and the portfolio company itself, as well as the estate plan implications of a variety of exit scenarios.

But even if exit planning was done at the investment stage (and even more so if it was not), once a decision has been made to explore exit opportunities, several actions should be taken - even before the exit process has been commenced:

1. Run a model. Using a range of potential exit valuations, run a model of projected outcomes, taking into account all transaction-related expenses, including fees payable to bankers, attorneys, accountants, and other advisors and consultants; transaction - triggered bonuses and other payments; debt repayments triggered by the exit sale; and of course, taxes - the amount of which may differ based upon transaction structures.

2. Pressure-test the estate plan. Once the model has been run, and a range of outcomes has been obtained, run those outcomes against the estate plan to see if any changes to the plan should be made in light of (and in advance of) the possible exit sale. Also, estate plan considerations may impact the structure of the exit sale, not just the transaction structure (merger, stock sale or asset sale), but also the form of, and timing of the receipt of, the transaction consideration.

3. Gathering the data. Even the best-run companies may not be ready for a sales process. Once the decision has been made to proceed with an exit, the portfolio company must pull together all relevant commercial, legal and financial information into a data room, to which access can be selectively granted. (These days, most data rooms are electronic; these are several third-party providers who can assist in establishing and maintaining one.) Having a well-organized data room projects to prospective purchasers that the seller is both serious and motivated, and allows for a reasonably quick due diligence process.

Once the data room has been established, it should be reviewed by the family enterprise’s advisors, to identify any potential issues that may arise as part of the due diligence investigation. Identifying any issues, and being prepared to address them when they arise, will prevent surprises (and price re-negotiations) during the sales process.

4. Process is everything. For family enterprises which make control investments, the extent to which fiduciary duties can affect the exit process can come as an unwelcome surprise. Particularly in situations in which there are significant minority investment stakes, great care must be taken to ensure that the sale process is transparent, that the board has fulfilled its fiduciary obligations, and that the sales transaction treats all parties fairly and complies in all respects with legal requirements. Often, when transactions are successfully challenged, it is not on the basis of the actual result that has been obtained, but on the quality of the process undertaken to achieve that result.

5. Experienced advisors make a difference. Many family enterprise investors have been through an exit transaction often, the transaction that created the family’s wealth. These investors understand that every sales transaction, even the sale of 100 per cent of a company’s equity for cash, is complex, and that the issues that arise require sophisticated analysis. For this reason, the retention of experienced financial, legal and accounting advisors is crucial to a successful exit sale. Experienced advisors can help avoid both the common and the unusual pitfalls in a transaction, and, working together, can help ensure the success of the exit.

Successful exits set the stage for future investments; family enterprise investors who have the reputation of handling exits in a professional and sophisticated manner are generally contacted for the best new investment opportunities. As the saying goes - when one (exit) door closes, another opens.

This article was previously published by Clearview Financial Media Ltd.