If you are a vendor in search of financing or hoping for a successful sale, first and foremost, you need to concentrate on the most appropriate purchasers or partners. Without this crucial focus, the process will be inefficient at best. At worst, value will not be optimized and there will be unwanted leaks and competitive harm. Now that the days of brief investment horizons, heady valuations, and ever-ascending, highly liquid IPO markets are in the past, there has been a return to the fundamentals in planning an exit.

In developing your strategy, you should first determine the prospective vendor's needs or objectives. This should result in a short list of meaningful alternatives that will include the following:

Restructure management
To relieve the entrepreneur of day-to-day demands while simultaneously preserving equity, hire a first-class president or dramatically step up the quality of middle management. You should be aware, however, that while independent management may be able to enhance value significantly, the entrepreneur may not be able to adapt to the newly evolving corporate culture. Establish a true board of directors with one or two independent members who have been down that particular road before and know what it is that needs to be done.

Recapitalize
Borrow from a long-term lender without personal recourse and draw out the funds. You can thereby continue to own 100% of the business - as well as having cash in the bank - providing the best of both worlds. There are no income taxes on disposition, no new partners (simply a nonrecourse lender) and no loss of control, and there is a continuing investment opportunity. While the business will be more highly leveraged afterward, the cash withdrawn will be an offsetting asset; however, it is reinvested. The withdrawn cash can be used for personal purposes or to invest outside the business and thereby diversify your holdings.

Active partnering
After many years of building value, an owner may want to withdraw significant capital from the business, yet maintain control, and this can be accomplished by bringing in a minority partner. There are many types of minority partners. Some want to share management and financial responsibility and are well suited to entrepreneurs who are "partner people." Others are families and private equity funds that are happy to take a minority position and share only strategic and director-type responsibilities.

Strategic sale or partnering
When the catalyst that the company needs is a strategic partner, a sale of control is usually required. The entrepreneur, however, can retain a meaningful minority interest with an agreement to sell it to the partner at a later date. The same result can be achieved by sale of 100%, with the expectation of a further contingent payment based on performance. The contingent payment, or earn-out, will bridge any valuation gap and also enable the entrepreneur to enjoy the fruits of some of the synergies that will come post-sale.

Often, the partnership can last for many years, whether the entrepreneur remains as a minority partner or a senior employee.

IPO or passive partnering
To attract more professional management and grow the business, an entrepreneur may require significant incremental capital. This can be achieved by either taking the company public or introducing an institutional investor. Neither can be considered an exit but rather a new beginning.

Management and employee buyers
Management will rarely have sufficient capital to purchase the business and merchant bankers rarely have operating experience commensurate with their financial resources. A marriage of the two groups, therefore, is ideal. A buyout without the involvement of significant third party equity is likely to be funded by a large vendor take-back. Because of conflicts and risks, however, the entrepreneur/vendor can rarely act simultaneously as a partner, lender and effective board member in the post-sale environment. The introduction of a merchant bank or investment bank to a management/employee group is often the ideal catalyst.

Nontaxable lenders, investors and buyers
Canadian pension funds are good buyers and partners. Because they are not taxable, they enjoy a higher return than do taxable purchasers. A 10% interest return to a non-taxable investor yields only 5% to a taxable one. Hence, real estate, debt instruments and certain cash-flow structures may have much greater value to nontaxable funds. Remember, too, that interest is deductible to the payor, so the entrepreneur pays only 50 cents, even though the nontaxable investor receives one dollar. Clearly, there's a dramatic opportunity here for entrepreneurs to leverage.

To ensure that the structure of the deal is optimally aligned, it is essential to test the targeted buyer, partner or financing solution against the vendor's criteria for a successful exit. To this end, the following things should be considered.

Net-after-tax cash proceeds to the vendor are usually, but not always, the dominant criteria. Continuity of staff and culture and leaving a legacy are often initially put out as critical factors but they are almost always displaced by price. After-market liquidity, governance and the terms of the shareholders' agreement may be as important as the up-front cash when an ongoing equity interest is being maintained.

When a minority partner is introduced, whether as new management or as a passive or an active partner, a successful relationship between all the stakeholders is more important than the modest amount that may be received for the interest sold. Setting reasonable expectations and pricing the minority share accordingly will buy tremendous support and alignment. You need only imagine having to attend regular board meetings with a president or fellow board member who overpaid, to appreciate how damaging a begrudging relationship can be in the long term. Where dramatic growth is expected and control, or a substantial minority stake, is being sold, long-term earnout provisions are often counterproductive. It may be more candid to recognize a partner alliance and to structure the post-sale shareholder relationships accordingly.

It is common for an institutional minority investor to require a "put," forcing the entrepreneur to buy out the minority investor in the event that the whole business is not sold within a certain period. This may effectively change the character of the alleged equity investment to a loan with a sweetener. This is even truer when there is a minimum return priority attached to the "put" price. Similarly, bringing in a partner who can be bought out under a "call" means that the stakeholders are not all in the same boat and will likely not all share the same objectives.

In light of the above, what should the mid-market company keep in mind when considering sale or introducing new debt or an equity partner? Remember, price is in the eye of the beholder. There is no substitute for seeking out a buyer for whom the business is a vital strategic acquisition. Financial buyers are generally likely to pay a more modest price than will strategic buyers in the near term, but they make good partners if the objective is to grow the business and then exit together.

Shopping for purchasers south of the border offers wide choice. Strategic buyers there are likely to pay a higher price and are used to buying growth acquisitions. However, shopping for a primarily financial partner is likely to be more effective closer to home because relationships, reputation and culture are much more critical to success. When there is more than one bidder for the business, the dynamic is very much in the vendor's favour. It is rarely necessary to consider more than two or three parties, since it is too difficult to maintain focus and confidentiality. If you do not have a high level of trust in the prospective purchaser, it is likely the transaction won't close successfully. The auction process must be carefully managed. Typically, confidentiality agreements are not worth the paper they're written on.

When selling to strategic or competitive purchasers, it is critical to reveal facts only on a need-to-know basis. For example, perhaps interviews with middle management and customers ought to be undertaken only after the purchase agreement is signed, everything else is agreed to, and these interviews remain the last condition to be cleared prior to closing.

"Pactive" partners - partners who are both passive and active as the occasion demands - are the best. Passive most of the time, they are actively involved only at the board level and in giving support during normal business down-cycles. They are not interested in running the business day-to-day and have a time frame of five to 10 years.

With financial buyers, it is important to understand the rules of the road. Their price is often based on a required risk-adjusted internal rate of return and they frequently benefit from aggressive leverage and are driven by shorter term performance-based managers. They usually estimate the fair market value of their private company investments on a regular basis and while this can be a helpful discipline, it can also be highly arbitrary and subjective. Timing is everything. Negotiate from strength and be strategic, not reactionary, in planning. Bring in a partner or sell when you are looking forward to a good year and there is no immediate pressure to do so. Do not wait for the top of the market.

When it is time to bring in a partner, the impediments are rarely price; they usually concern culture, psychology or governance. Matching the entrepreneur's expectations with those of prospective purchasers or partners will ensure an efficient process and a successful exit. Knowing the characters of the vendor and purchaser will ensure the leopard needn't change its spots.