Are you the owner of a Professional Services firm? If so, congratulations. Now, have you thought about how ownership stakes in privately held companies like yours get monetized? In the event of a sale, would it be you who is receiving liquidity—or are you the one providing it?
I remember an acquisition I worked on where there were senior partners with control nearing retirement and several younger partners who each owned minority stakes in the business. The older partners had proposed that their interests be bought out by the younger partners. To help the process go along, the senior partners had arranged a $25 million loan to the business to pay for the buyout. Such a loan would, of course, entail personal guarantees.
The younger partners were presented with a dilemma: They could each increase their stakes in the business and collectively control it but would have to take on—and be personally liable for—the $25 million in debt. It would take years before the debt could be paid down. What would happen if there was a downturn in their industry? Plus, the senior partners were retiring. Would that impact their client base? Did they risk losing everything by buying the controlling stake?
The younger partners turned down the plan due to the risks involved, so an opportunity opened up for an entity backed by private equity to acquire the business. As we explained how the acquisition would work, the younger partners sat in stunned silence. Instead of possibly owning the entire business, they were now going to be part of another entity, primarily because they had not been willing to take on the debt necessary to buy out the senior partners, but also because there were no planned transfer programs in place to address this issue.
In the end, the transaction with the PE-backed firm was completed and all partners initially became key employees of the acquiring entity.
What does this mean for you? If you have a benevolent founder, one who is willing to defer payments for the value of their equity over time, then you may be able to transfer ownership without outside capital. But not all founders/senior partners are so generous. Barring that, the only way to provide liquidity to the retiring partner is to find outside capital—either debt or, as in the example above, a strategic acquisition backed by private equity.
If you find yourself in this situation, my advice is to develop a plan, control the process and look at the many alternatives before making a decision. That way, you will not have a transaction imposed on you without having some input into who the transaction partner is (whether a private equity firm or another strategic buyer) and what their plans are for the business you have built.
Kelly Kittrell has more than 30 years of merger & acquisition and corporate finance experience. He advises business owners on sell-side and buy-side transactions, valuation analysis, corporate finance and equity and debt financing. Contact Kelly at [email protected].