Exit Planning is a process involving developing and planning an optimum time to exit a business with the objective to achieve the maximum return out of the accumulated wealth made over the tenure of the business.
I. Planning an exit strategy:
If you are setting up a business you will have a clear vision as to what you desire to achieve out of it. Similarly, to derive the optimum value from the business, you need to have a vision of how and when you will exit the business. Defining and planning an exit strategy is essential at the point of starting a business as this would enable the business owners to mould their business in the ideal shape of the chosen exit option. The way in which the business owner exits can affect the value the shareholders derive from the business, the future success of the business, its expansion plans and its products and services.
When it is considered that the sale of a business is probably one of the most significant events in the life of a business owner, it is surprising that so little organized thought goes into it. One problem is that business owners view the disposal of their business as an event somewhat out of their control that will happen one day, whereas they should consider an exit as a process over which they can exercise considerable control even from the start of the business.
It is important that the structure of the business (with regard to how it is owned and what it does) and the relationships with any co-owners are properly organised so that one does not limit the exit opportunities and does not become liable to pay more tax on the sale proceeds than is legally necessary. Ideally, the structural issues should be addressed from start-up itself, thus ensuring that at the time of exit one is not at a disadvantage.
One needs to evaluate various options while determining an optimal exit strategy. Business owners should not expect to exit successfully without figuring out how best to exit, what preparatory steps to be taken and the value unlocking from the exit.
II. Various Exit Strategies:
Selection of strategy and structure depends on whether it is a partial or complete exit, tax implications, time is taken for completion and optimum transaction cost and acceptability of the structure to the regulators. The transaction should be structured in a way that the seller gets the highest net of tax consideration without having any negative impact on cash flow of the buyer.
Strategic Sale: A strategic sale involves various stages:
- The business should be brought into a proper shape by reducing unnecessary overheads, debts, and excess stocks, paying all the taxes and resizing the balance sheet.
- Appointing financial and legal advisors
- Valuing the business
- Identifying and evaluating various potential buyers
- Carrying out negotiations with the potential buyers
- Completing due diligence
- Completing various legal formalities
- Obtaining approval from various authorities
- Finalizing the sale and transferring ownership
Strategic sale creates the highest value for the seller as the buyer is ready to pay price for intangibles, goodwill, customers etc considering synergies which he can capture from the acquisition
This transaction is that of a strategic sale by erstwhile Satyam Computer Services to Tech Mahindra, whereby Tech Mahindra acquired a 31% stake in Satyam. The deal positioned Tech Mahindra at the fourth position in the IT Industry from the seventh position. The deal enabled Tech Mahindra to move into several geographies using Satyam’s spread and was able to get into other verticals inorganically.
Reorganization of the business for partial liquidity
The business may reorganize for the objective of the seller is to have partial exit either in terms of ownership or in terms of one of the division or strategic business unit (SBU). For that purpose, depending upon the legal entity through which business is carried on, may have to reorganize the capital, refocus on various business units and or create new legal structure.
Demerger of Wheels Division of Enkei Castalloy Limited to and in Enkei Wheels (India) Limited
Enkei Castalloy Limited (ECL), was engaged in the business of the manufacture and sale of castings made from aluminum alloys, for automotive and non-automotive applications (the Foundry Division) and manufacture and sale of alloy wheels for automotive applications (the Wheel Division)
The Wheel Division required new and latest technology to improve its competitiveness against the recent entry of globally-positioned competitors and to develop future markets both in India and overseas. It also needed a substantial infusion of risk capital to fund initial losses and expansion. Therefore the Enkei Wheels (India) Limited (EWIL) was the company formed for the purpose of taking over the Wheel Division on an ongoing concern basis from the Demerged company.
Demerger of the Engines and Auto Components Business of Kirloskar Oil Engines Limited to and in Kirloskar Engines India Limited
The Demerged Company was a Company engaged in the business of manufacture and sale of diesel engines, generator sets, bimetal bearings, bushes and bimetal strips. The Demerged Company being engaged in the Wind Mill Business and as an investment company and focusing on new business opportunities demerged its Engines and Auto Components Business to and in Kirloskar Engines India Limited by way of a Scheme of Arrangement.
- Recapitalization of business: The equity shareholders may recapitalize by re-leveraging the equity, replacing equity with more debt in order to extract cash from the company
Before a complete sale or inviting a strategic partner, the business owner has to take out surplus /non-strategic assets and cash so that the buyer gets what he is interested in.
- Merging the business to enhance value and marketability: Merging the business involves the steps similar to a strategic sale
Reliance Natural Resources Ltd. (RNRL) – Reliance Power (R-Power)
On July 05, 2010 RNRL merged with its sister concern R-Power in an all-stock deal with a swap ratio of 1:4. The merger will accelerate R-Power’s plans to set up a 10,000-Mw gas-based power plant, set in train with its Gas Supply Master Agreement with Mukesh Ambani’s Reliance Industries Ltd. The move will also help R-Power accelerate its backward integration plans as a pure thermal power generation company to quickly venture into other value chains of the energy business.
- Transferring the business to family, management or employees
- Gifting the business to meet personal or tax planning goals
- Liquidating or partially liquidating the business
- Sale of a stake to partners, strategic buyers, competitors, international buyers or to the public
Angel Investors Exit: Angel Investors invest at the early stages of a business. Therefore from an Angel perspective, a company can either:
- Obtain financing from a venture capital fund
- Be sold
Private Equity/Venture Capitalist Exit: Venture Capitalists/private equity investors normally look for exit by either going public or through a strategic sale
3i’s Stake Sale in Pipe Maker Welspun
The UK-listed private equity (PE) firm 3i sold off one of its early investments in India in steel pipe maker Welspun Gujarat Stahl-Rohren. 3i, which had picked up about 6.6% equity stake in Welspun Gujarat for about Rs 350 crore in 2007 through the private-investment-public equity route, sold this portfolio due to limited growth opportunities in the pipeline industry. The firm has been realigning its portfolios across the world after the liquidity crisis and has even closed down its buyout fund in India and shifted people to its more active infrastructure fund. – Source Economic Times, 21st September 2010
Leveraged Buy Out:
A leveraged buyout, or LBO, is an acquisition
of a company or division of another company financed with a significant amount of debt
. Later, the acquired company’s profits are used for the repayment of the loans. This acquisition method became very popular in the U.S. in the 1980’s when easy financing was available through innovative securities like junk bonds.
Usually, the acquired in a leveraged buyout takes the target company private through the transaction. That means it will buy out the entire stake held by the public and delist from the listed stock exchange if the target is a public company. This can give the acquirer the freedom to execute major changes in the acquired business. After the reorganization of the business, acquirers such as specialized LBO funds usually exit from the company.
Various types of methods are used for the exit. One is selling out the company to a strategic buyer. Another exit strategy is making a fresh IPO if the company has been taken private for realizing the gains. Another option is the recapitalization of the acquired company in a manner that the buyers can extract money from it.
LBOs in India
LBOs completed in India are different from those in the U.S. and other developed countries which are normally carried out by specialized investment funds. In India, LBOs are carried out by business groups or companies to acquire foreign companies with the help of new found sources for providing a large amount of credit as a result of the liberalization of the Indian economy. Moreover, the target companies are usually many times bigger than the Indian acquirers.
The first global LBO in India was the acquisition of Tata Tea’s acquisition of UK-based tea company Tetley in March 2000. After that, two other companies under Tata Group made similar transactions. They were the acquisition of Corus Group by Tata Steel and Jaguar by Tata Motors.
Many other Indian companies have carried out LBO transactions after 2000. Birla Group company Hindalco Industries’ acquisition of Canada-based aluminum producer Novelis, Chennai-based oilfield equipment producer Aban Offshore’s acquisition of 33.76% stake in Norwegian oil rig producer Sinvest, Vijay Mallya’s UB Group’s acquisition of Glasgow-based whiskey maker Whyte & Mackay, Dr.Reddy Lab’s acquisition of German generic drug maker Betapharm, Wind power major Suzlon’s acquisition of Germany-based RePower Systems are various examples of LBOs carried out in India.
III. Considerations on sale of a business:
Before selling the business, a business owner needs to consider the following carefully and accordingly plan for the exit:
- What is the net worth of my business?
- What is the optimal time for the exit?
- What is the optimal exit strategy for the business?
- What are the legal/financial and other hindrances on the exit of a business?
- What are the various regulatory compliances and approvals to be undertaken?
- Whether shareholders (including minority holders) can object to the exit?
- What will be the tax liability on exit and whether there are options available to reduce the tax liability?
- What are the synergies available from the exit?
- What would be the appropriate valuation matrix?
- Who are the potential buyers of the business?
- Whether proper due diligence of the buyers has been carried out?
IV. Valuing the business:
When considering an exit strategy, it is important to understand the value of the business, as the sale price will influence both the current and post-sale plans.
Key considerations while valuing the business are:
- Reviewing the revenue and the business models
- Projecting the financials and cash flows of the business
- Reviewing risk and returns
- Tax considerations
- Which assets and liabilities are taken over
- What would be the structure of the deal
- Legal and financial implications
V. Conclusion – Benefits of a planned exit:
Every step along the complex path of executing an exit strategy demands advice from professionals who are experts in the area and who know the opportunities and the pitfalls. Advice from these experts would help the business owner plan the exit in the most efficient manner and avoid any potential risks. The employment of a team of professional and experienced advisors will add a cost of say 3-6% of the transaction, but will potentially add considerably more value by:
- Mitigating against a failure of the transaction
- Expediting the transaction completion process
- Intermediating the process to eliminate the risks associated with direct negotiations between the business owners
- Increasing the negotiation value of the transaction
- Providing a team of professionals to structure and execute the transaction
Therefore an exit strategy should involve a carefully planned activity considering the advice of the experts.