Using Other People's Money to Slash Risk and Boost Growth
BY Max Safavi
The partial sale of a well-managed company can be just the key to growth for the business and financial security for the owner.
Business owners are always searching for ways to maximize return on investment and minimize risk. One often-overlooked way to position yourself to do just that is to sell a major portion of your business. It allows you to use other people’s money to grow your business in ways you could never achieve via traditional organic growth.
Owners of many privately-held middle-market businesses have a large percentage of their personal wealth invested in their company. If the company grows and performs well, their personal wealth multiplies.
However, there are numerous risks business owners cannot control that could wipe out a large share of their personal wealth overnight. What are these? Downturns in the economy, developments in technology, market obsolescence, the loss of a major customer, new competitors, and changes in government regulations, for starters. These are in addition to the always-present possibilities of personal tragedies, such as a terminal health issue or the death of the business owner or key management personnel.
There is an alternative. if a successful business owner sells a major portion of their company to a private equity group they can use the proceeds of the sale to make prudent investments. They can remain involved in the business and look forward to a secure financial future for themselves and their family. It is important for the business owner to recognize and exploit this opportunity and maximize their return on the investment they have already made in the business.
Here is a real-life example. A 22 year-old entrepreneur purchased a franchise store. He worked hard, managed wisely and by the time he was 42 he owned 88 stores that generated approximately $5 million in annual profit. Most owners would be thrilled to own such a profitable company.
Recognizing that he needed to diversify his investments, and reduce his risk, he decided to sell the company. He worked with an investment banker who identified a private equity group that purchased his company for approximately $25 million. After paying taxes, the owner would have netted approximately $19 million. Once again, most owners would be very happy to walk away with $19 million.
The private equity group borrowed 65% of the purchase price of the company and invested $8.75 million of the firm’s funds in the company.
The original owner was not ready to walk away and wanted to remain actively engaged in the company. Therefore, as part of the sale, he negotiated the right to buy back 40% of the company at the buyer’s invested cost. This enabled him to purchase 40% of his original company for only $3.5 million, (40% of the $8.75 million the buyer invested) and received non-dilutive stock in the new company.
After paying taxes and buying back 40% of the company, the owner invested the $16 million he netted from the sale with a wealth management firm and has been earning approximately 10% annually in relatively safe investments. Meanwhile, as an officer of the new company, his salary and bonus was increased by a multiple of five times after the initial transaction.
The private equity group wanted the company to continue its growth, and was willing to invest to make sure it did so. In less than three years, they provided the funding, resources and talent to grow the company to more than 350 stores and increased the annual profit to more than $30 million.The owner of the original company has been actively involved in directing the growth of the new company and managing day-to-day operations. He has $16 million in the bank earning him over a $1.5 million in annual income and now owns 40% of a 350-store company that could be worth an estimated $100 million. In five years this owner used other people’s money to accomplish what would have taken him 20 years as an independent owner of the business in perfect business conditions.
The private equity group is currently evaluating an opportunity that would add another 350 stores, bringing their total to 700 stores, making it the largest chain in the franchise and perfectly poised for an IPO or a purchase by a large corporate buyer. Were this to occur, the original owner would own 20% of a 700 store chain.
The private equity group also benefited from this transaction. It’s poised to realize a 35% gain on their original $5.25 million investment. They did this by purchasing a profitable, well-managed business and recognizing that they needed the original owner’s expertise and experience to maximize their own return on investment.
Using other people’s money is the ideal way to reduce risk and maximize return on investment. Selling a portion of your business, investing those proceeds with a solid wealth management group, and retaining part ownership enables an owner to secure his or her financial future, and provides an opportunity for substantial future gains.
IMAGE: 'Ajnagraphy' / Flickr.com
Last updated: Nov 14, 2013
MAX SAFAVI has executed more than $400 million in mergers and acquisitions transactions and served as CFO for Microdyne and EF Johnson Technologies. He is a graduate of the Wharton School of Business and a Vice President at Allegiance Capital Corporation. @MiddleMktMandA