Taking Money Off the Table
Successful entrepreneurs frequently invest a significant part of themselves into their businesses: their time, their expertise, their passion -- even their financial security. After years of focusing so intently on growing their companies, it's no surprise that many business owners reach a point where they find too much personal wealth is concentrated in their businesses.
During the boom years from the mid-1990s to 2000, entrepreneurs tended to solve this problem through IPOs. Today, with a less frothy market for going public, company owners are increasingly turning to another liquidity option that allows them to raise cash, diversify their personal portfolios, and retain control of their companies.
Their liquidity option: taking partial liquidity out of their companies through private equity investments.
This trend is becoming more evident. Founders of high-profile companies including eHarmony.com, an online dating service; M-Audio, a manufacturer of digital audio products for home recording; Fastclick.com, an online advertising firm; and optionsXpress.com, an online stock and options brokerage, have all taken this route to in recent months.
Joe Greco, the founder and owner of PSC Info Group, a two-time Inc. 500 company, did the same. Joe started a document and information management company while still in high school, convincing 12 companies around his hometown of Norristown, Penn., to let him print their billing documents. He bought a small printing press and operated at night out of his parent's home. Over time, he expanded his business dramatically. By 2002, he was serving a global clientele and earning gross revenues of close to $50 million a year.
As PSC Info Group became larger, it started to attract interest from private equity firms as well as corporate acquirers. However, Joe wasn't ready to sell. "I was enjoying my success, and my goal was just to keep growing," he said. "I wanted to build the business until it was a cash cow, and some day, maybe take it public."
Yet at the same time, he was concerned about concentrating all of his wealth into a single asset: the business. He wanted to diversify his own financial portfolio, while providing the cash PSC Info Group needed for continued expansion. Furthermore, he was looking for additional resources -- outside expertise, board members, and capital – to take his company to a new level.
However, Joe did not want to sell 100% of his business.
Joe was able to achieve partial liquidity while remaining firmly in charge of the company. He eventually decided to sell a stake in his company to a private equity firm. The sale provided him with shareholder liquidity, enabling him to diversify his personal financial holdings. At the same time, the private equity firm provided strategic advice to the company at the Board level, helped expand the company's sales and customer base, and offered expertise in finance and operations. Today, Joe remains CEO of PSC Info Group, with the private equity firm as his sole investor, and continues to enjoy profitable growth.
Accessing liquidity while retaining control
Entrepreneurs often worry about the risk of taking cash in exchange for selling a stake in their business because they fear losing control of their company. The good news is that some private equity firms, especially those that invest in successful, established companies, prefer to leave day-to-day business operations and decisions in the hands of the CEO and management team. The entrepreneur continues to run his business, while the investor provides support and strategic advice to help the company reach its full potential.
How founder's liquidity financing works
Most private equity investors require a track record of several years of positive cash flow before they will consider offering founders' liquidity to a company owner. They focus primarily on entrepreneurs that have self-financed their way to success with little or no previous outside investment. These factors indicate that a company's business model works well -- and is likely to continue working well going forward.
There are typically three ways to obtain personal liquidity. In most cases, the private equity investor buys stock in the company from the owner, providing cash in return. However, cash infusions can also be structured so that a minority investment finances dividends to the owner or retires a loan the entrepreneur has made to the company.
Owners can sell anywhere from a small portion of their company to a majority stake, depending on their needs for liquidity. The private equity partner will, however, want to ensure that the entrepreneur and his team retain ownership incentives that are sufficient to motivate them to continue growing the business.
Personal liquidity transactions allow business owners to diversify their ownership stake -- without selling out completely. Entrepreneurs maintain an ownership stake in the company, and continue to benefit from future appreciation and growth. And, if there's an IPO or sale down the road, the entrepreneur will receive a second liquidity infusion as well, further increasing his or her financial stability and reward.
Founder's liquidity = financial security
For company owners, such as PSC Info Group's Joe Greco, taking some money off the table through a private equity investment can be the first step towards financial security. It allows them to diversify their assets, withdraw cash for personal needs, and plan effectively for long-term goals such as retirement, while at the same time benefiting from the insights of an experienced business partner.
SIDEBAR: What is Founder's Liquidity?
Founder's liquidity, also known as shareholder's liquidity, is when founders and/or shareholders realize liquidity and convert part of their ownership interest to cash. This financing also allows owners to diversify their holdings and increase their personal financial security, and enables management to retain strategic control of the business. Such financing can be used for either minority or majority transactions.
Tom Roberts is a managing partner of Summit Partners, a private equity and venture capital firm with offices in Boston, Palo Alto, and London. Summit Partners invests in growing, profitable, privately held companies. Tom can be reached at 617.824.1000 or firstname.lastname@example.org.