Have you already planned your exit strategy?

Every day I see how some entrepreneurs are associated without having a clear exit strategy. By associating I mean becoming part of a society, company, or legally binding project.

A partnership with a third party is like a marriage, it can be great or a disaster depending on how well those in the couple understand each other, the tastes, interests, goals and plans they have in common and the ability to live together with each other.

Normally when you get married you have the opportunity to live a courtship, the courtship allows you to know the personality of the other however in business many people “get married” when they barely know each other, or have never worked together. The problem is that sometimes the expectations of synergic contributions of each partner to the business are not met, whether economic, support, business development, networking or management.

When this happens, the fights or divergences in the interests begin, one partner works a lot and the other does very little but has the same percentage of profits. Another possibility is a partner wants to reinvest all the profits to accelerate the growth of the company and the other wants to distribute dividends because it has many personal commitments (eg, several children in the university, other projects or large obligations) and does not care much for long-term growth.

Before partnering, try to establish a clear exit strategy, this identifies expectations prior to getting married, which can be done through a partnership agreement.

Exit strategies could include:

In case one of the partners does not want to continue in the company, a valuation of the company will be made using the accompaniment of an investment bank with recognized experience. Once the result is obtained, each partner will offer the other a purchase value. This can be done in the form of using a sealed envelope where the largest offer acquires the shares of the other.

Exit multiples can be established, for example multiple X of the EBITDA of the year less financial debt at the date, a multiple of the book value of equity, of sales or of net profits. These multiples must be established objectively with the help of an expert in business valuation. Likewise, Put and Call options over shares can be negotiated, which give you the right to sell or buy shares with pre-set conditions.

Another alternative in case none of the partners has the economic resources to pay the other, is to establish a royalty on sales in perpetuity or for a certain period of time with certain guarantees in case of default.

A certain part of the shares could also be converted to preferential ones, so that said partners receive a preferential dividend and do not have a vote in the main decisions of the company.

The form of payment of the participation of the partner that sells may be flexible in case there is trust between the parties and real guarantees are established.

In case you have one or several partners and no longer feel comfortable working with them, another alternative is to carry out a leveraged repurchase of shares, where the company itself is the one that repurchases the shares and to do so requests a bank loan or a Mezzanine-type credit. The interest paid to the financial creditor is tax deductible, generating an anti-dilution effect in which future profits are shared among fewer shareholders and some financial indicators could be improved. For example the WACC (weighted average cost of capital) and the ROE (return on equity).

A few years ago we accompanied the raising of capital for an entrepreneur who had a specific commercial knowledge that was very valuable in a certain industry, in this case, the financial partner that was sort to leverage the venture via Equity (equity) offered to be the administrative and financial manager of the society. After two years from being founded and capitalized the business was going very well but the relationship of the partners deteriorated due to divergences of interests. In this case the entrepreneur with the commercial knowledge had to get another investor to acquire the participation of the first capitalist partner, however it was an uncomfortable and expensive process.

On another occasion several brothers and cousins ​​inherited an important company founded by their grandfather. The majority partners were paid very high salaries and fees and did not share all the financial and commercial information with the minority partners. They were also not performing good management in the administration of the company by wasting important assets and available resources. Currently the whole family is divided and in an expensive process of lawsuits between them.

We have also seen where one partner who part owns the company and withdraws surplus liquidity without permission and uses the resources for personal things (eg. a political campaign). On another occasion one of the partners is getting a divorce and part of the organisation’s operation ends in the hands of a third party that has nothing to do with the management of the company, causing the latter to lose the motivation to continue working. This type of situation puts into question the sustainability of the company.

The differences between partners can lead companies to deteriorate. It is a must to be well advised when creating companies or entering into partnerships.

Mezzanine financing is a modern way of financing companies or projects with a hybrid between Equity and Debt. For example, credit with a fixed interest rate plus a spread tied to the EBITDA margin, the credit can be convertible in shares in case of selling the company. This financing is more expensive but it can be very flexible and it can be supported. For example by the company’s shares without other real guarantees of personal items.

Author: Simón Restrepo Barth, Master in Finance, Professor, Partner of ONEtoONE Corporate Finance.

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