Situation: A founding CEO is evaluating a purchase offer for his company. The buyer wants the CEO to retain some ownership interest to assure a smooth transition post sale, and ongoing assistance from the CEO so that the company continues to succeed post-sale. Should the CEO retain a minority share of the company? How do you structure an earn-out?
Advice from the CEOs:
The ideal option is full payment up-front. However, if the CEO is perceived by the buyer as critical to the company the buyer will want to have some assurance of continued services for some period.
An earn-out of fixed payments over time is acceptable provided that the language of the agreement is acceptable. However, performance-based earn-outs make no sense if the CEO no longer has control over the decisions that will impact performance. Don’t structure the payment as an earn-out, but as a retention bonus and assure that the terms are favorable.
Post-sale a minority share of your old company holds no value if you can’t monetize it. Holding a small share of a non-traded company has the same challenges.
It is all about liquidity.
If the other party offers this, ask what is the value is to you of the retained share.
Minimize the earn-out if one is demanded, but don’t count on it.
If there isn’t a strategic fit between the buyer and the company, the value of the company in a sale will be lower.
Situation: A company needs to expand to meet growing demand and has opportunities to expand in several locales. They can finance this expansion through bank loans, or by selling either a minority or majority interest in the company. How do you raise capital for an expansion?
Advice from the CEOs:
Minority shareholders have appeal. Just be aware that they have rights. If they own interest above a certain percentage, they gain legal rights such as the ability to force liquidation. Research this percentage, and figure out a percentage of minority ownership that will work for you. Based on this, look for a minority partner who will give you the capital to expand for ownership below this threshold.
Consider a hybrid solution combining a smaller loan with sale of a limited percent of the company.
This is a risk equation.
The loan option is risk / reward for long term profit. You may have to secure the loan with personal assets.
On the other hand, selling a minority interest could set you up for life.
Look at both options, plus your personal goals and decide which combination of risk, reward and personal security fits you best.
One sale option is a phased buy out.
Example: sell 30% now, with options under conditions that you accept, to buy a larger share of your company later.
Continue to involve the key stakeholders in these discussions.
Assure that you secure your own future, and then secure the future of other family members.