For many entrepreneurs, entering into a sales process is a final (mental) step, after which they look forward to the moment of transfer. Other entrepreneurs find entrepreneurship too much fun and should not think about this at all. How is that with you? Do you see the importance of a good and timely transfer, but don't want to stop completely yet? Then the pre-exit offers a solution.
A pre-exit involves selling part of your company. Usually this is to a private equity party or a strategic buyer. This allows you to continue to build the business together and secure some of the assets invested in the business in advance.
This also ensures the continuity of the company. This is because it creates a longer cooperation period in which the investor wants to facilitate the final transfer as well as possible.
How does a pre-exit work?
With a pre-exit, you and an investor or strategic buyer set up an investment holding company from which the company is taken over. As the seller, you finance the acquisition by contributing shares (as a deposit and/or loan). The other party deposits and/or loans a substantial amount to the investment holding company to finance the purchase of the remaining shares. A portion of the operating free cash flow is then used annually to pay off the contributed debt, pay dividends and achieve growth.
A pre-exit is different from a partial sale financed with loan capital. This is because a horizon for the company's growth path and the current owner's final exit is already set in advance.
Relatively complex construction
As the selling party, you must realize that from the first tranche of the pre-exit, you no longer have full control over the company. Over time, differences in vision can cause problems, making the pre-exit structure not ideal for stubborn entrepreneurs.
Moreover, market forces can disrupt the timing of the second tranche of the transfer. Finally, a pre-exit is relatively complex compared to a full sale. Many scenarios must be considered and all agreements must be properly recorded to maintain some degree of certainty.
Synergy
The biggest advantage of the pre-exit strategy is that you can combine knowledge and expertise in the partnership, which creates synergies. In addition, both the selling party and the investor can provide capital relatively easily to facilitate further growth. When the agreed exit deadline (usually 3 to 7 years) is reached, you as the selling party can sell your remaining shares, which, if all goes according to plan, will have increased in value.
Cigar out of your own box?
It is important to realize that the pre-exit can also be seen as a cigar out of your own pocket. After all, the question is whether the increase in value could have been realized even without a private equity party or strategic buyer. Moreover, after the first tranche of the pre-exit, as an entrepreneur you no longer receive 100% of the return, but only the return of the interest for which you still participate.
You may be able to achieve more returns when holding 100% of the shares than in the pre-exit structure. Therefore, it is crucial to think about the purpose of the capital released beforehand. If those assets are not yielding returns, the financial benefit of the pre-exit will be limited.
What does a pre-exit provide?
In summary, the pre-exit structure can be a good solution to ensure continuity, pool knowledge and expertise, secure assets and realize value growth.
However, you must be sure that the increase in value is sufficient to compensate for a (mostly) lower return on the secured assets, and that this increase in value is really the result of the cooperation. If it is not, the only benefit is that you can use the secured assets (the cigar) sooner.
