21.09.18

The “Two Pay Day” Structure

Selling a business is a major event in an SME owner’s life and something that most only ever do once.  Reaching the decision to sell your business can be a long, tumultuous process and is often a result of several catalysts.

By Tom Matthews

Selling a business is a major event in an SME owner’s life and something that most only ever do once.  Reaching the decision to sell your business can be a long, tumultuous process and is often a result of several catalysts (e.g. succession planning, pressure from a spouse, birth of a grandchild, etc.).

The three key objectives of SME owners when contemplating a sale of their business

When business owners are considering selling, they tend to focus on three key objectives:

  1. The dollars
  2. Their people; and
  3. Their legacy.
Options available to SME owners when selling their business

Unfortunately, many SME owners are not aware of the potential options available to them when selling their business.  Many owners automatically associate selling their business with an outright sale and don’t consider the alternatives.

One such alternative is a partial rather than full sale of the business.  By selling part of their business on completion and retaining an ongoing equity stake, SME owners can realise some of the value tied up in their company but ride the next stage of the growth journey.  They can therefore benefit from an additional “pay day” on exit of the enlarged group.  This is known by growth investors as the “two pay day” structure.

What is an outright sale?

Under an outright sale, a seller will typically receive a cash payment on completion for 100% of their business.  Sometimes a buyer will link some or all of the consideration payment to certain future milestones (e.g. the renewal of a key customer contract, achieving the budget for the current financial year, a satisfactory handover period, etc.).

Advantages of an outright sale

The key advantages of an outright sale for a business owner are (usually):

  1. A simple transaction structure
  2. Certainty of proceeds
  3. No on-going involvement in the business post sale (or after the handover period)
Disadvantages of an outright sale

The key disadvantages of an outright sale can be clearly linked back to the three key objectives of business owners when selling their business:

1)    The dollars

An outright sale might not be the value-maximising outcome for a business owner.  If a potential purchaser is interested in acquiring the SME owner’s business, then it is likely that they see some strategic benefits to their organisation in doing so.  These strategic drivers are set out in my previous article but are usually because the potential purchaser believes in the future growth opportunity of the target business.  If a business owner sells 100% of their company, then they will not get to benefit from the ongoing growth of their organisation after the sale and will therefore not share in the upside.

2)    Their people

Most SME owners feel a strong sense of loyalty to their staff.  These are people that they have personally developed over many years and often include family members.  Knowing that these people will be looked after post the sale of the business is therefore key.  If a business owner sells their company, then they will not have a say about what happens to the people that continue to work in their business post sale.  Sometimes the purchaser might even be looking to achieve cost savings by replacing staff at the SME business with their own people.

3)    Their legacy

SME owners are not like most people.  They are individuals who decided they weren’t going to follow the “usual” career track of “get a job and work your way up the corporate ladder”.  They are risk takers who decided to do things their way.  They have put blood, sweat and tears into building their businesses.  Many have been on the brink of failure and went on beat the odds and create a successful company.  As a result, SME owners tend to be extremely passionate about their businesses – they often view them like one of their children.  As such, they typically want to know that their child will be well looked after post sale and the legacy they have built will go on to flourish.

Business owners should give consideration as to whether an outright sale meets their specific objectives or whether an alternative option might better suit.

The “two pay day” structure

As growth investors, we often utilise what we call a “two pay day” structure to seek to address all three of these key objectives.  The “two pay day” structure involves a partial sale with some cash out on completion to a business owner and an additional pay-out on the sale of the wider group.

Selling a part of your business can help to de-risk your own personal finances whilst allowing you to stay closely involved and in control of your business.  With the combination of personal financial security and the help of an experienced growth investor, business owners can afford to be bolder in their strategic decision-making.

Advantages of the ‘two pay day” structure

The “two pay day structure” seeks to address all three key objectives SME owners consider when selling their business (i.e. dollars, people and legacy).

1)    Dollars

By partnering with the right growth investor, SME owners may be able to achieve accelerated revenue and profit growth in their business over and above what they could have achieved on their own.  Growth investors can provide the finance, strategic support and access to networks of experts to accelerate business growth.  As a successful growth investor, the way we typically do this is via serial rounds of financing to support organic growth initiatives and strategic, value‑enhancing acquisitions.

By selling part of their business on completion and retaining an ongoing equity stake, SME owners can realise some of the value tied up in their company but ride the next stage of the growth journey.  They can then benefit from an additional ‘pay day’ on exit of the enlarged group.  This “two pay day” structure often generates higher total proceeds for SME owners than if they sold 100% of their business.

2)    People

By maintaining an ongoing equity stake, SME owners can stay closely involved and input into all key strategic decisions.  As growth investors, we look to incentivise the key people at the heart of the businesses that we invest in.  This is often through equity participation to ensure interests are aligned.  This typically involves bringing the key people who run the business on a day-to-day basis into the equity and supporting their transition from employee to equity owner.  By bringing in the right investment partner, SME owners can be sure that their key staff (many of whom are often friends and family members) will be looked after.

3)    Legacy

Selecting the right investment partner to fund rapid and sustainable business growth can help to take the company forward to the next stage.  This can leave a successful personal legacy for the SME owner.

What option is best for me?

Every business owner will have different priorities when selling their business.  Whilst an outright sale might well be the most appropriate outcome for some, it is important SME owners realise there are alternatives that might better achieve their key objectives.  My advice to SME owners is to explore all options available to them when considering selling their business and then select the option that works best for them.

What next?

If you are a business owner wishing to explore the options available to you regarding selling your business, then I would be happy to share my thoughts on the optimal solution for you.  Please contact me at info@pemba.com.au me to find out more.

Photo by Debora Cardenas on Unsplash

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