Don’t sell your business - sell a piece of it!

February 14, 2022

Owning and operating a business is rewarding but altogether a risky endeavour. A common pitfall for founders who successfully manage to create cash flow in their business, is that most if not all their net worth gradually gets tied up in a single asset (their business). It can seem like the only option for realising a return on the value created in the business is to sell it off completely. However, a full acquisition means a full exit thus foregoing all future returns as the founder and leaving it to the new owners taking it over. Bittersweet is the experience of departing a business built from the ground up only to watch it reach new heights under new management.

To minimise regrets and mitigate the risks associated with ownership, business owners are starting to open their eyes to the option of a partial sale. Selling a piece of their business allows them to stay invested in future upside while realising a return on the value of their asset. These so-called recapitalizations or partial buyouts help investors buy either a majority or a minority stake in the enterprise, while the founder retains residual ownership, enabling them to remain involved in the ensuing success of their business. In that way, selling less than 100% ownership is a way for founders to achieve a partial exit by taking some chips off the table and onboard equity partners to share in the burden of owning and/or operating a business.

Reducing ownership risk

Unsurprisingly, most of a founder's wealth is locked up in their company. This makes sense because small private businesses are a fairly illiquid asset class and taking cash out of the business always comes at the cost of the growth it could have contributed to had those resources been reinvested instead. However, many entrepreneurs struggle with the fear that one day their business might become obsolete, for example because of a shift in technology, consumer preferences or new players bringing competing products to market. This fear is a strong motivator for founders to cash out all their chips and sell off their business. 

This is where partial exits come in handy. Prudent business owners can ensure they get to lead a comfortable lifestyle by selling a stake in their business and taking home enough cash to secure their way of life. This security allows entrepreneurs to focus on running the company they built without growing too risk-averse because mistakes could mean their personal financial ruin. And there are several ways to structure a partial sale depending on whether founders want to sell a minority stake to stay in operational control, or take a step back by selling a majority stake to an operator.

Liquidity with future upside

Ownership in a small business is about as illiquid as it gets. As opposed to the public markets, small business owners cannot simply list shares to be sold to a retail investor on Robinhood, nor do the largest institutional investors take an interest in them. Hence, liquidity is usually constrained to pay out earnings, which can be especially difficult if a business is very capital intensive, for example if it holds a lot of inventory or has a lot of staff on payroll. 

So far, many entrepreneurs have seen full buyout as the only alternative to get a good amount of cash into their pockets. This, of course, has most of them looking for a new job or a new project to start afterwards, speculating what would have happened if they had stayed with the business. 

The trend of partial exits marries the benefits of both aspects. Entrepreneurs get to withdraw a large amount of liquidity from an accredited investor via a secondary transaction - often much, much more than they could ever be withdrawn from bleeding the business for its profits - while maintaining their stake in the future upside of the company.

million dollar payout

Double dipping

Maybe the most convincing reason for business owners not to sell their company immediately is the so-called double dip. This option allows founders to sell a majority stake of their business to an investor but stay on for a while longer. In this time, the investor and the entrepreneur collaboratively grow the company, fueled by the operational expertise and leverage of the investor. 

Down the road, typically after a few years, both the investor and entrepreneur sell off the business collectively to a sole acquirer (sometimes with the help of a business broker). Because the business has grown after the founder sold their majority stake they get to sell on the remainder of their shares at a higher valuation, allowing them for a second, potentially much more lucrative “dip”.

A helping hand

Experienced investors such as small private equity firms, family offices and angels tend to go above and beyond the capital they supply to the founder. Assets especially helpful such as relevant network, operational expertise and financial engineering know-how can elevate the entrepreneur’s business to the next level. 

This help can be especially impactful for founders who are domain experts but seek a set of complementary skills to balance out their operations. Many technical founders of SaaS businesses for example benefit from the marketing and sales prowess which business savvy investors can bring to the table.

Finding an investor

Matching the right business with the right investor is challenging. Entrepreneurs are commonly left to Google search for potential equity partners, use whatever personal network they have or to simply wait until someone reaches out. Investors, on the other hand, often have to scour the web for suitable businesses and spend immense amounts of time cold-emailing their founders with limited success. This is where our platform, BitsForDigits, helps both parties connect around the concept of partial buyouts - anonymously and free for founders!

Useful resources: Selling a minority stake, Primary vs secondary offerings, Selling a majority stake, How to grow a business after buy-in

About the author
Laurits Just

Laurits is the co-founder of BitsForDigits. He has extensive experience in the world of startups, tech and finance. Before building a Micro Private Equity marketplace, he worked for BlackRock and Rocket Internet.

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