When selling a (small and medium-sized) business, the conversation quickly turns to price. But in practice, the form of the deal is at least as important.
Roughly speaking, there are two flavors: a complete exit or a pre-exit. Both options can work very well, but a successful deal depends on the deal terms and the role of the entrepreneur after the transaction.
Below we list the most important differences and points of attention so that you can take these into account early in the sales process.
What is the practical difference?
Full exit: you sell 100% of your shares and are done after a transfer period. The advantage is simplicity and clarity: immediate redemption of shares, less (future financial) risk, fewer discussions after the sale and often more freedom after closing to focus on other things.
Pre-exit: you sell part of your shares, remain a shareholder in the company, and remain active for a period of time. Financially, in many transactions this can lead to a higher total return on the sale of your company. This is because you still own shares for a period of time after the first sale moment in which you share in the increase in value toward a second sale moment.
The increase in value during this period is mainly due to accelerated growth as a result of multiple acquisitions(add-ons) that are made. This is because larger businesses are generally sold at a higher multiple. The downside is that you trade immediate security for a second sale opportunity in the future with market and execution risk.
Full exit vs. pre-exit: what are the advantages?
Full exit:
- Capital redemption: you receive the purchase price and after the transfer you are truly 'free' (subject to a possible earn-out or vendor loan);
- Less complexity: no shareholder agreements on control, budgets and information provision;
- You limit future exposure to market and execution risk (less dependent on how the buyer steers).
Pre-exit:
- Chance of higher returns through the second sale moment (multiple arbitrage);
- More room for growth investments (professionalization, buy-and-build) with shared risk;
- Gradual transfer: you can transfer knowledge and customer relationships in a controlled way, which stimulates continuity.
5 questions to answer
- What do you really want: to exit, downsize or grow? If you want to be unstuck within 12-18 months, a complete exit is often a better fit. If you still have 3-5 years of motivation to build, a pre-exit may make sense, provided agreements support it.
- What control do you have over strategy and money? Think about budgets, investments, hiring/firing MT and acquisitions. Establish 'reserved matters': subjects that require your (co-)approval.
- What does your role after the transaction look like (and what if it chafes)? In a pre-exit, you often stay on as a director or adviser. Agree on specifics: tasks, authority, time allocation, remuneration and a workable exit scenario if the cooperation ends ('good leaver' vs. 'bad leaver').
- What is the path to the "second payoff? A pre-exit is only really interesting if you know when and how your remaining shares can be sold. Look at drag-along/tag-along, agreements on sale timing, valuation methodology and information/reporting rights.
- What risks do you continue to bear? Think about guarantees/indemnities, reinvestment (roll-over), and financing structure. In a full exit, you want to mitigate these risks; in a pre-exit, you want to know what risks you find acceptable in exchange for additional upside.
Take-away
Pre-exit or full exit are not 'better or worse', but different packages of security, control and (potential) return. As a seller, you avoid regrets by not only focusing on price, but by deciding early on in the sales process what is really important to you: complete exit or continuing for another period of time and possibly additional upside through value increase.
Use the 5 questions above to focus on your preferred route and then have this documented in the transaction documentation.
