What are the most common options for shareholders looking to exit their company?
On most occasions, when a person sets up a company or buys shares in a company, the possibility of an “exit” (i.e. selling their shares to realise their value) at some point in the future will have crossed their mind.
There are several routes for shareholders to consider when looking to exit a business. Which one is right for you and your business will depend on a number of factors, including your long-term goals for the company and your timescale for receiving the funds. There will also be external market factors which will affect the types of exit options that are available to shareholders at the point they decide to sell.
In this article we will look at some of the options for shareholders considering an exit, and the drawbacks and advantages of each option. However, regardless of which option fits you and your business, consulting a corporate lawyer and corporate finance advisor at an early stage will allow you to put your company in the best possible position when it comes time to proceed with the exit.
What exit options there are to consider?
Whilst there are several exit options you could consider, three of the most common are:
- A sale of the shares in the company to an unconnected third party (also referred to as a “trade sale”).
- A sale of the shares in the company to a group of core management (or a new company formed by them). This is typically referred to as a “Management Buyout” (MBO).
- The establishment of an Employee Ownership Trust (EOT).
Share sale to an unconnected third party
A sale of the company’s shares to a third party is the most common route for shareholders looking to exit. Typically, the third party will want to buy all of the shares in the company, so this will require the agreement of all of the shareholders (unless “drag along” rights are in place and some shareholders can be required to sell).
Advantages of a share sale include:
- A large proportion of the purchase price is likely to be paid up front, on completion of the sale.
- This can be the best option if a shareholder is looking for a clean break, although sometimes the buyer will want the shareholders to be involved for a short period following completion if they are particularly key to the business.
Disadvantages of a share sale include:
- As the buyer is unconnected to the company, there will normally be an extensive due diligence process for the buyer to learn about the company and any risk areas.
- The buyer is likely to ask for extensive warranties about the company and its affairs, meaning that it is possible for a breach of warranty claim to be brought against the sellers which requires some of the purchase price to be returned (this risk can be mitigated in the sale process with a Disclosure Letter).
- Potential for the third party to significantly change the culture and practices of the business and alienate staff who remain in the business.
A MBO involves the existing management team of a company acquiring a controlling stake or all of the shares in the company from the shareholders. This option can be appealing to shareholders who have faith in the company's management and believe they can drive the business forward successfully.
Advantages of a MBO include:
- The due diligence process is likely to be streamlines, given the management team already have good knowledge of the business.
- There are likely to be limited warranties as compared to a share sale.
- There is the possibility of greater retention of the business’ culture with the existing management team remaining in place.
- The selling shareholders will likely have confidence that the existing management team will maintain the culture and ethos of the business after completion of the sale.
Disadvantages of a MBO include:
- It is likely that the management team will not have the funds to pay out a large portion of the purchase price on completion, so shareholders may have to receive their payout over a longer period of time.
- A MBO requires a strong and motivated management team to be in place, who have the funds (or who can secure the necessary borrowing) in order to complete the purchase.
Employee Ownership Trust
EOTs have gained popularity in the UK as a unique exit option for shareholders who wish to reward and retain loyal employees – see our article here. In this arrangement, shares are sold to a trust which is established for the benefit of the employees, providing them with a stake in the company's success.
Advantages of an EOT include:
- There are tax advantages for both the selling shareholders and the employees.
- An EOT can foster a positive and motivated work environment, as employees have a direct interest in the company's performance.
- In the same manner as with a MBO, the due diligence process and warranties will be limited, given that there is no unconnected third party involved.
Disadvantages of an EOT include:
- As with a MBO, it is likely that most of the purchase price will be paid out over a period of several years, effectively on the back of the trading profits of the company.
- There are a number of strict rules which must be complied with in order to obtain the tax advantages.
If you would like to discuss any of the options outlined above, and how you can put your company in the best position to prepare for an exit, please contact our Corporate and Commercial Team via firstname.lastname@example.org or call 01603 601911.