Finance & Operations

Not Ready for an Exit, but Want to Extract Equity?

March 29, 2011

As a startup founder, you may be enjoying running your business and are too young (or not ready) to retire. At the same time, you’d like to be more financially secure and remove some of the risk you’ve assumed as the business’s owner.

Exit / 20080225.10D.48494 / SML

Or, maybe the company is on the precipice of significant growth. In order to help it expand, you need access to capital, but you don’t want to go into debt to accelerate that growth.

So, what do you do?

Let’s assume you have significant equity tied up in the company and you’d like to extract some without exiting the market. If that situation applies to your business, you may want to consider a partial company exit strategy. It will allow you to cash out on the company’s success, without losing control or selling the business outright.

If that’s the route you’re ready to go, here are the three most common partial payout scenarios:

Minority Investment

In this scenario, you sell a non-controlling portion of your company to a private equity firm or venture capital company. This enables founders, investors, and executives to monetize their equity while at the same time providing the company with growth capital.

A minority investment often comes at the expense of ownership dilution and allowing a third party to have some say in business decisions. However, in some instances, the investing company will also grant you access to its internal consulting resources, allowing you to optimize your sales, marketing, positioning and recruiting strategies without having to pay for an outside consulting company’s assistance.

If you go the minority investment route, this Inc.com article is a good read, letting you know which pitfalls to watch out for and what qualities investors will be looking for in your business.

Leveraged Recapitalization

With a leveraged recapitalization, your company takes on new debt in order to pay investors, shareholders, executives, and option holders a one-time dividend. Similar to a minority investment, this approach enables investors to get a return on their investment now instead of waiting for an IPO or strategic acquisition.

On the plus side, this method does not require the company to take on a new group of owners. But the main disadvantage to leveraged recapitalization is that the new debt also comes with covenants that require your company to hit specific financial targets and can require lender consent for other types of corporate development activities in the future.

If you’d like to read more about it, Glenn Scolnik, the owner of a private equity firm, wrote a guest article for Entrepreneur.com that does a great job of explaining when a leveraged recapitalization makes sense for small business owners and what their options might be.

Sell Equity to Key Employees

In this scenario, you and your partners agree to sell off part of your equity to key employees. The advantage of this strategy is that it gives employees the opportunity to share profits, which will increase motivation. The downside is that you typically need to sell off stakes to several employees to access your targeted level of equity, leading to too many decision makers or influencers at the firm.

There are a lot of resources out there that break down when and how to sell equity to employees, but Wikipedia provides a nice, all-encompassing reference guide for the various employee ownership models and options.

So, should your company consider any of those partial exits?

That really depends on your current situation and your goals for the future of the business. If a partial exit is executed in a clear and planned manner, it can spur innovation and growth by introducing new ideas and people with different experiences and skills to your business. It will also allow you and your partners to extract and enjoy some of the wealth you’ve worked hard to build.

However, if the partial exit is executed poorly, extracting equity from your business could suggest that your commitment to the company is waning. That perception could scare away future investors, potential acquirers, and customers. So, in order to to execute a successful partial exit, management must clearly convey its rationale and demonstrate the ownership team’s commitment to the business.

Now you know your options for liquidating part of the equity in your company. Before you decide to pull the trigger, be sure that it makes the most sense for you, your partners, and any other investors.

Marketing Manager, Pricing Strategy

<strong>Brandon Hickie</strong> is Marketing Manager, Pricing Strategy at <a href="https://www.linkedin.com/">LinkedIn</a>. He previously worked at OpenView as Marketing Insights Manager. Prior to OpenView Brandon was an Associate in the competition practice at Charles River Associates where he focused on merger strategy, merger regulatory review, and antitrust litigation.