Why should a founder sell less than 100% of their company?
Founding and running a small business is not only hard but also incredibly risky. In order to realize a return on what they have built, business owners often sell their company, for example to a private equity investor. Following this transaction, founders often leave their enterprise only to see the new owner take it to the next level, which can feel bittersweet to witness.
What many founders do not know is that there is an alternative to selling their entire company: only selling a piece of it. A partial buyout is where investors buy either a minority or majority stake in the business, which allows founders to stay invested and actively involved in their company. The act of selling a stake in a venture to an external investor can also be referred to as “recapitalization”. Although these partial exit deals can be very beneficial for both founders and investors, they are still not top of mind for most business owners looking to de-risk their ownership and take some money off the table, which is a shame.
Minimizing the risk of owning a small business
Most founders have all or most of their net worth (capital and wealth) tied up in their business. Ergo, if the business should ever fizzle out due to XYZ reasons, the founder’s livelihood would be at stake. The weight of that risk is overwhelming to some and therefore often the main motivation behind an exit. Partial buyouts, however, allow business owners to hedge their bet just enough to secure their living standards and focus their energy on running the business for the long-term. Think of a hedged bet as an insurance policy issued by co-invested partners enabling the founder to take the business all the way with peace of mind.
Getting liquidity while realizing future upside
Shareholders of public companies have the luxury of being able to cash out ownership in their investment at a whim. Stakeholders of private companies unfortunately do not have this option. Their options for realizing piecemeal returns are either to grant themselves a higher salary or pay a dividend from the company’s earnings. But these are rarely life-changing liquidity events. Alternatively, founders can sell the entire business in a cash buyout, but then accept the fact that all future growth of the company accrues to the new owner. Not only that but exited founders usually also have to find a new occupation forever wondering what could have been.
Suspend the prior options for a minute and consider instead the possibility of a partial exit. It combines the best of both worlds by allowing the founder to extract a lump sum from their ownership without losing their entire stake in the future upside of their business. And who says you can’t have your cake and eat it too?
Taking advantage of the “double dip”
Another big driver of partial buyouts is the opportunity to “double dip”. Dipping in in this context refers to a partial sale where founders can realize an immediate cash return upon selling a stake in their business once and then cash out again when they sell the remainder of their ownership later. Within a few years of the first dip, the company can have increased its value significantly, yielding a much higher return overall for the founder upon their second dip when compared to exiting the business in one go.
This scenario is commonly practiced by founders who sell a majority stake to operating partners, e.g. search funds and roll-ups that seek to actively optimise and/or scale the operation with the support of the founder either to keep or sell the business to a third party down the road.
Obtaining strategic support from investors
Professional private equity investors usually not only supply capital but also bring invaluable experience, network and operational excellence to the businesses they buy into. These capabilities gained from growing, scaling and optimising other companies can be the key to unlocking the full potential of a founder’s bootstrapped business. That’s why founders are wise to seek out and onboard equity partners with expertise complementary to their own skill set in order to boost the overall trajectory and value of the company. If founders do not want to see their investor involved in their day-to-day operations, they can also rely on them as an advisor, which can yield similar benefits.
Finding the right partners
Professional investors that specialize in recapitalization and partial buyouts include private equity funds, family offices, search funds, high-networth individuals, business angels and more. Discovering and connecting with these, however, can be difficult. Traditionally, founders had to wait to be contacted by an investor and then encountered the disadvantage of having no competing offers to negotiate a better deal with. And using brokers comes with a lot of headaches including misaligned incentives and giving up a big cut of the transaction. New marketplaces such as BitsForDigits seek to improve the discoverability of suitable investors and businesses, providing a platform to founders free of charge.
Cashing out or fueling the business
When selling equity, founders can consider two options: selling primary or secondary shares. Primary offerings refer to newly issued shares of common stock. Most importantly, money raised by selling primary shares befalls the business itself, not the founder. Hence, this option suits itself for a business that is in need of capital to run and grow its operations. Business owners benefit from a sale of primary shares if they want to see more capital being put to work in their company. This will however dilute their overall ownership.
Secondary offerings refer to existing shares of common stock sold to a third party. Contrary to transacting primary shares, secondary shares will create a windfall for the selling party, for example the founder. As such, secondary sales are recommended to founders who want to realize a return on their efforts of building a business and/or who seek to de-risk their ownership.