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Posted: June 27, 2011

Planning for liquidity

Will you be ready when it comes time for an exit?

Kamal Gala

Whether your business is established or just emerging, it will likely benefit you in the long-term if you take the time now to plan and prepare and position your company to take advantage of a liquidity event at an opportune moment. With financial markets continuing to improve, we have seen a string of IPOs this year, with even more in the queue. Many companies are able to secure credit at low interest rates and confident buyers are using cash from their balance sheets. These conditions could offer prepared companies attractive opportunities to maximize exit opportunities.

Factors to consider when choosing the most appropriate type of liquidity event

Every business is unique. The right exit strategy will depend on the market as well as your objectives as a business owner. Some things to consider:

• What future role, if any, do you want to have with the company?
• Do you want to keep the business within the family?
• How will a liquidity event impact your employees?
• Is there a business culture that you want to preserve?
• Are market conditions right? Is there currently strong demand for your company's products or services? Are the IPO and M&A markets flourishing?
• Do you want to keep competitive information, such as pricing data, confidential?
• Who do you want running your business and will you be okay with their plans for the future?

A brief description of some alternative exit strategies

Just as every business is unique, so is every deal. Not all liquidity options will be suitable for your business. Each liquidity option results in a different set of outcomes depending on the type, ownership structure, financial condition, and other aspects of your business. A few of the more common liquidity options include:

• Strategic Mergers and Acquisitions (M&A) - Combination of companies into one legal entity or the acquisition or disposition of a business by the purchase or sale, respectively, of the assets or equity of that business.

• Employee Stock Ownership Plan (ESOP) - Sale by a company of its equity interests to a trust benefitting the employees of the company.

• Initial Public Offering (IPO) - Initial sale of a business's registered equity to the public.

• Private Equity - Sale of a company's equity to a financial buyer.

• Taxable Recapitalization/Redemption -Redemption or repurchase by a company of its outstanding equity, often using borrowed funds.

Some pros and cons of certain exit strategies

Some liquidity options may look appealing, but your company may not be a suitable candidate to pursue all of the options. There may not be a single exit strategy that encompasses all of your objectives. Factors to evaluate when charting your company's future include:

• M&A:
o May be a good option for healthy businesses as this can offer potential growth or return for an acquirer, especially in the case of a strategic alliance.
o More attractive if the company has few or no skeletons in the closet that would deter potential acquirers.
o Requires opening books and making full disclosure to potential acquirers, which could be problematic if the potential acquirer is a competitor.
o The process is disruptive to operating the company.
o Results in loss of control of the business for the business owner and may result in a change of management.

• ESOP:
o May be a good option for a business that is profitable with steady growth, borrowing capacity, and no current need for growth capital.
o Helpful if the company is closely held.
o Good choice if the goal is to maintain the business culture.
o Aligns the interests of employees with those of the company.
o Offers estate planning and family succession benefits for the business owner and provides a retirement plan for employees.
o Allows current management to stay in control.
o Complex structure that may complicate the future sale of the business.
o Must disclose some business information to employees.

• IPO:
o May be a good option for a company with high or steady growth and significant use for growth capital.
o Requires sophisticated operational and financial management, and excellent controls and procedures.
o Control stays with existing management and board of directors.
o Equity can be used as acquisition currency and to incent employees.
o Results in heightened profile for the company.
o Requires significant regulatory and disclosure compliance.

• Private Equity:
o May be a good option for a business that is mature, has steady cash flow, potential for growth, little debt, and reasonable future capital requirements.
o Usually results in the private equity firm controlling the board of directors and the direction of the company.
o Can provide a significant purchase price in good markets.

• Taxable Recapitalization/Redemption:
o May be a good option for a company that is privately held, stable, and has no current need for growth capital.
o Allows current management to stay in control and keeps the culture of the business intact.
o Tax inefficient for the business.
o Business must have borrowing capacity or other source of capital.

You have already built, or are in the process of building, a successful business. Now is the time to start planning your exit strategy so you can reap the rewards of your hard work. Remember that the decisions you make now may have significant implications down the road, so do not be afraid to turn to your advisors to help you plan ahead.
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Mr. Gala is an attorney with Holland & Hart. He counsels public and private companies on a wide variety of corporate and securities matters, including mergers, acquisitions, divestitures, venture capital and private equity financings, equity and debt offerings, and securities reporting and compliance. He can be reached at 303-295-8581 or kkgala@hollandhart.com.

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Readers Respond

Kamal, I enjoyed your summary of business owner exit options. If you have the time, I would be interested in meeting you for a cup of coffee to discuss how we might work together on future transaction. Best regards, Joe Durnford Sr. Managing Director JD Ford & Company By Joe Durnford on 2011 07 14

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