Editors’ note: This is the second of a three-part series from Lawn & Landscape on exit strategies for business owners. Watch for next month’s installment, which focuses on ways to build your business with the end game in mind.
This month we explore three separate strategies commonly used by green industry business owners seeking to exit their company or to achieve some measure of liquidity. When the day arrives for you to cash out – in whole or in part – chances are you’ll do so through a third-party sale, a private equity recapitalization or formation of an employee stock ownership plan (ESOP). Each of these three strategies will enable you, as the business owner, to trade a portion or all of your interest for cash. Here we’ll briefly detail the differences between the strategies, so you can begin to determine which path might be the best for you, your company, your employees, your family and your customers. Understanding your end game options will help you drive your company to the best position for achieving maximum value when the time is right.
Strategic Third-Party Sale
Perhaps the most widely known of the three options is an outright sale to a third party. Usually, a third-party sale means that you, as the business owner, will sell 100 percent of your ownership interest in exchange for cash.
This type of transaction is typically referred to as a sale to a “strategic buyer.” The buyer is strategic in the sense that they are typically already active in the green industry and are looking to expand their business through targeted acquisitions. Your company must fit their acquisition profile, likely in terms of size, geographic footprint, customer base and business mix. There may be a strategic buyer already active in your area looking to add to their market share, density of routing and customer roster.
While there have been numerous strategic buyers in the green industry over the years, certainly the two most prolific are Brickman and ValleyCrest. These buyers are looking for good companies run by good people. While the equipment, facilities or other assets that come with the deal are important, the landscape industry’s strategic buyers are focused on your reputation, your ability to deliver the highest level of service at a competitive wage and your valued and valuable clients.
While the third-party sale is perhaps the quickest and cleanest way to cash out, some business owners have reservations about the strategy as a solution. A strategic buyer will look to integrate your company into theirs, which could lead to some loss of staff. It also will mean a loss of the brand name and corporate identity that’s such a part of the culture you have built. This can be a tough pill to swallow, yet it might make the most sense for achieving your personal, financial and professional goals. The landscape business is a relationship-based business that thrives or dies based upon the people who make it happen every day. The strategic buyers respect the relationship aspect of the business and therefore are looking not just at you but the quality of your staff and the likelihood that they will stay if things go as planned.
For the business owner seeking substantial liquidity, but willing to continue to lead the business for several years, or for the owner looking for capital to grow the company, a private-equity recapitalization might be the best fit. In a private-equity recapitalization, an institutional investor, like a private-equity group (PEG), acquires an interest in the company with the agreement that the owner and his team will stay on to grow the business both organically as well as through acquisitions. In a recapitalization, the business owner receives substantial personal liquidity and diversification for the interests sold. Although a PEG typically acquires a controlling interest, this strategy allows the business owner to remain a significant shareholder and continue to be the driving force behind the company. Unlike strategic buyers, PEG buyers often look to maintain the brands they acquire, realizing the value in brand recognition and the loyalty of the management, employees and clients. Therefore, post-transaction, the company will likely continue to operate under the same brand name. As financial buyers, PEGs do not want to be involved in the daily operations of the business, but rather are looking to contribute capital and other resources to help leverage the talents of the existing best-in-class team. The PEG’s goal will be to partner with the business owner to grow the company over a period of four to seven years, on average, and then sell it to generate a return to their investors. Most equity groups have a well-defined strategy as to the type and size of companies that they invest in, how they structure their deals and their investment time horizons.
This deal is often the best choice for an owner who wishes to get substantial liquidity off the table, yet keep their brand and their team to grow the business with continued upside and significantly lower personal risk. The best candidate companies for a private-equity recapitalization will have a well-thought-out plan in place to grow the business more aggressively. In a recapitalization, size matters and only larger companies will likely attract a PEG. In fact, the largest strategic buyers in the market have received significant PEG investment. One such group is Yellowstone Landscape Group, which is financed by Gridiron Capital, the purchaser of a number of larger players in the Southeastern and South Central U.S. PEG-supported strategic buyers are actively focused on investing in new platform companies in specific markets as well as adding-on with acquisitions in their existing markets.
Employee Stock Ownership Plan
While perhaps the most maligned and misunderstood of the three options, the ESOP might be the only choice for some companies, and the best choice for those seeking to retain and reward employees while reaping the significant tax advantages the ESOP provides. An ESOP is another liquidity or exit strategy that allows the selling shareholder to get full, fair market value for any interest in the business that is sold, yet maintain operational control. The unique aspect of an ESOP strategy is the ability to reward employees with real ownership in the company. Further, if properly designed and implemented, an ESOP can create exceptional tax benefits for both the selling shareholder and the company. Considering the projected 40 percent rise in capital gain rates later this year, an ESOP is a timely choice for maximizing value.
The ESOP strategy is similar to the others in that the starting point is negotiating the value of the company. Once value has been established, then the company must secure financing for a loan to the ESOP. The ESOP will use the funds to purchase the business owner’s stock, which is then allocated among employee accounts in the ESOP.
Over time, as the company generates profits, the bank loan is paid down and the employees’ ESOP stock accounts are filled with allocations of shares in the company. The ESOP can therefore serve as a qualified retirement plan for company employees, allowing them to retire with significant stock value in their ESOP account.
While the tax benefits of the ESOP vary depending on a host of factors, including what type of entity you have chosen for your company, they can be substantial. With guidance from excellent advisors, this strategy can result in tax savings for the company and for the selling shareholders, helping them to avoid paying capital gain taxes on the value received from the sale of their stock to the ESOP.
The tax benefits and the prospect of sharing of real ownership with key employees are often the driving factors in the creation of an ESOP. However, the ESOP may be the only real alternative for liquidity if a strategic or PEG buyer does not materialize with a value that represent a full, fair market return to the shareholders.
Understanding your options for exit well in advance is a powerful tool for growing your business in the right direction. Armed with your options and an understanding of your company’s EBITDA valuation, as we explored last month, you’re ready to take action to increase your EBITDA and achieve maximum value when it’s time to cash in on your hard work.
Next month we’ll explore concrete ways to build your business with the end game in mind.
The author is the managing partner of CCG Advisors. Send him an e-mail at firstname.lastname@example.org