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This Two-Step Way for Harvesting the Value in Your Business Is Not for Everyone

April 19, 2022 | By John Warrillow

If a big goal feels unachievable, it can be tempting to break it down into smaller steps.

For example, if your goal is to gain admittance to an elite four-year college in America, rather than apply out of high school, you may find it easier to attend a two-year junior college (JUCO) and then transfer to a four-year school upon graduation. The two-step approach can seem more attractive (and achievable), but as anyone who has attended a JUCO will tell you, there are many risks. For example, how do you know you’ll get the grades in JUCO to transfer into a four-year school? Will your credits transfer? What if you get distracted at JUCO? The list of potential roadblocks is considerable.

Similarly, if your goal is to sell your business to a strategic acquirer in ten years, you can distill your short-term options into two buckets. The first is to put your head down for the next decade and focus on building the value of your business so that it will be irresistible to a strategic acquirer one day.

The other option is to achieve your goal in two steps by first selling part of your business to a private equity group and then relying on their capital, knowledge, and connections to get you to your goal of selling to a strategic acquirer. These days, private equity groups are flush with cash, and if you run a successful company, you’ve likely been approached by one.

The Pros and Cons of a Two-Step Approach

Both approaches to building and harvesting the value in your business have pros and cons.

In the first approach, where you maintain 100% of your equity as you build the value of your business, you are in total control. You get to decide your strategy and how to execute it.

The primary downside of going it alone is that you may be risking a substantial portion of your net worth if your business makes up most of your wealth. All companies have risks, and yours are amplified by having such a consolidated position in one company. The other disadvantage of remaining independent is that you must rely on yourself for critical decisions. You cannot depend on someone else’s network to help you expand your business. You are on your own, for better or worse.

The other option is to take a two-step approach to harvest the value in your company. With this strategy, you sell a piece of your business to a private equity group in the short term and roll some of your equity into a new business they fund. In this model, you can take some of your chips off the table. At the same time, since you will remain a shareholder, you stand to benefit if your private equity backers successfully sell your company in the future.

While this two-step approach has some advantages, it has its downsides. In most cases, you give up control of your business when you sell part of it to a private equity group, and you can end up with a significant portion of your wealth tied up in a company you don’t control.

The trick is to be honest with yourself about what is important to you.

Take James Benham as an example. Benham co-founded SmartBid, a software product designed for general contractors to solicit and manage bids from their trades. As he described on a recent episode of Built to Sell Radio, SmartBid had many inbound inquiries from investors and acquirers.

However, Benham knew he didn’t want to sell to a private equity group and become a minority shareholder in a company he had started. Benham knew he wanted to get 100% of his cash at closing and was not prepared to leave part of his proceeds at risk in an earn-out. Benham also had a software development company he was growing parallel to SmartBid, so Benham only wanted to sell SmartBid’s code and customer list. He wanted to take most of his employees to his other company in an ideal world.

A deal that allowed Benham to take most of his employees with him to a new venture and would pay him 100% at closing would be unacceptable to most private equity groups. They typically don’t have the managers to run the businesses they acquire and therefore need the founder(s) to stay on. Because Benham wanted all of his cash at closing, he didn’t include private equity groups on his long list of potential acquirers.

In the end, Benham sold to a strategic acquirer called Roper Technologies (NYSE: ROP) for seven times revenue and received 100% of his cash at closing, with no earn-out.

The key is to understand your temperament. Selling to a private equity group usually means you are no longer the sole king or queen of your kingdom. While you may still run your business day-to-day, you will now have shareholders who will want—even insist on—a say on critical decisions. If you like collaborating with others and want to de-risk, selling part of your business may be the perfect way to have your cake and eat it too. However, if you’re a lone wolf and the idea of checking with others before making a decision makes your stomach turn, the two-step approach to harvesting the value of your business may not be the best approach for you.