When looking for the best way to exit your company the range of choices can be daunting. This article, co-authored by Simon Pearson, Anna Faelten and Fraser Wood from EY’s TMT Corporate Finance team, evaluates some of the options available to founders.
The first article in this series ‘‘Are you prepared for exit?” explored how to prepare your business in the 18 to 24 months preceding a sale. Preparation is undoubtedly a critical step on the route to exit, which includes careful positioning of your business for sale (see the second article, “Strategic positioning”). However, equally important is selecting an exit route that suits the objectives of the founders.
Sale, IPO or PE?
There are a variety of different exit options. These include a full sale to domestic or multinational corporations, private equity funds or selling shares on the public market in the form of an Initial Public Offering (“IPO”).
It is clear from our recent Fast Growth Tracker, a survey of entrepreneurs in the UK providing insight into the exit routes they consider, that the majority of scaleups (59%) are mainly thinking about a sale to an international corporate buyer. The appeal of this exit route initially appears obvious, a bigger company can do the heavy lifting through leveraging its size and expertise into more customers in more countries more quickly. But it doesn’t always work that way.
At the same time, 73% of respondents to our survey are considering a sale to an international or domestic corporate, with 15% expecting to pursue an IPO. Notably just 9% are considering an exit to Private Equity (“PE”).
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There are clear differences between getting acquired and going public. While an acquisition can lead to attractive pay-outs for the founders and employees, it can often be an end game. Going public is more like restarting, just on an open stage. Depending on the circumstances PE can be an end game or an intermediate step in the journey to going public or a sale to a trade buyer.
Public companies are accountable to a wider audience and face increased regulatory pressures. However, publicly traded shares can provide benefits, which a private sale cannot.
Public companies have the opportunity to use company shares to develop an M&A strategy and fund acquisitions, build public image and brand awareness while retaining a share of future upside.
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An IPO brings with it additional pressures. As well as the significant continuation and upfront regulatory costs surrounding a public listing, companies have to live with quarterly or half yearly earnings reports – public investors can be unforgiving with negative surprises, tending to reward consistent and predictable performance.
Small companies, depending on their business model, may struggle to achieve low volatility earnings growth. Moreover, small cap public companies listed on a lesser known exchange receive a lack of coverage by analysts and brokers, leading to a business whose potential is not fully recognised by the market If a company is still in ‘hyper-growth’ phase and reinvesting all earnings back into the company, public investors may perceive this poorly and lack of dividend or bottom line growth can cause a drop in share price.
So size matters – larger IPOs attract more of equity research coverage and have a deeper pool of investors and larger companies tend to have less earnings volatility.
Sale to a trade buyer
In contrast trade buyers will be more likely to take a long term and inherently strategic view of a business, sacrificing short term performance for fast growth, and often providing capital investment or bolt-on acquisitions to help consolidate a company’s position in the market. Trade buyers buy for a range of reasons, such as:
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- to access IP and/or know how,
- to access new geographies in line with their current model
- to consolidate with an existing operation
- to develop a new offering for existing customers
- to strategically move into a new market
The exact combination of drivers will influence their view of valuation and structure.
Liquidity on tap
The third exit option is a sale to PE directly or to a PE-backed trade buyer. This market has deep liquidity and frequently has more predictability than either a sale to trade or an IPO.
In many niche markets the number of true strategic trade acquirers can be a finite number and not all will be in place to make an acquisition when you want them to. Their collective minds can be elsewhere, e.g. integrating other acquisitions, launching a new organic product, or dealing with a profit warning or bedding in a new leadership team to name a few distractions.
PE has grown to be a massive global economic phenomenon, providing the liquidity on tap to fill the need in the market for exit events between trade sales and IPOs.
Exiting via IPO, PE, or corporate sale have varying benefits, and the best route is often specific to each company and founder. The synergies achieved by trade buyers can often result in a premium valuation to an IPO, however the offer can sometimes include a significant earn-out component or require commitment to a minimum term with the business, limiting a company’s ability to achieve a full exit up front.
Dual or triple track
For high quality businesses a creative process to handle these choices is to let the market help them decide. They can do this by running a dual or triple track processes – preparing for an IPO while simultaneously pursuing M&A opportunities. In principle this is designed to keep a company’s exit options open until the last possible minute, allowing a founder to gather all of the critical information and choose the route that they find most appealing.
Running each process simultaneously allows companies to flush out potential acquirers using the IPO market. The competition of an alternate exit route is often a powerful tool to increase buyer appetite. Whilst each route has a number of common elements in terms or data and process requirements it is fair to say that having all options open has a higher process cost and takes up significant management time testing the underlying strength of the business. So choice comes at a cost.
The dual track process is particularly attractive during times of market volatility, when a limited window is available to IPO and sudden unexpected changes in market sentiment can adversely impact valuations. However, the process is, inherently, more complex, time consuming and expensive than running an IPO or private sale process in isolation, and it is important to judge early on whether the management team will have sufficient time to dedicate to both.
Going big or going home
One of the most important considerations when evaluating exit routes is the role that the founder or founders wish to have in the company going forward.
For those wishing to maintain control and run the company, an IPO or some PE deals will allow them to remain in the driving seat while selling a portion of their shares.
On the other hand, in most cases a corporate sale takes this decision out of their control. There are exceptions to this where trade deals are minority or joint ventures structures but these are relatively rare.
The ownership of the business transfers to the acquirer who then has the option to replace the company’s leadership team as they see fit.
Whichever route founders chooses to take, it will be tiring, hard work and at times frustrating, but the tangible benefits post exit are worth it.
The next article in this series will take a deeper look at the route to exit through sale, discussing the merits of an acquisition by both trade and private equity buyers.