Smart Exit (an entrepreneur’s perspective)
This article was prepared for and first appeared in Which Lawyer in Romania 2021
Author: Răzvan Vlad
An interesting topic that has emerged these days, despite the COVID-19 pandemic and the economic turmoil triggered by it, is how an entrepreneur, who has built a business along the years from the ground up, would be willing to make an exit and, more specifically, under what terms and conditions.
It is a relatively known fact that the entrepreneurial market in Romania was at its peak prior to the COVID-19 pandemic; however, despite the current situation, the market still offers good opportunities for those interested in investing in this type of businesses. Needless to say, many start-ups were created during the economic growth of the Romanian market in the years following the 2008-2009 financial crisis, with some of them being particularly appealing to investors. Noteworthy transactions have been successfully completed in recent years, particularly in the field of technology and fintech.
In this context, we would highlight certain aspects that might be relevant for entrepreneurs who are interested to pursue an exit or even to be involved in a process that would result in an exit.
With this in mind, we created a checklist, which is, by no means, a restrictive or exhaustive one, with aspects that entrepreneurs should keep in mind in case of an exit, as well as aspects that should be avoided.
A few key elements are high on our list, specifically:
- From a business perspective, as the owner of the target company, the entrepreneur should attempt to maximize business performance to make the business more attractive to the investor. The revenue streams have to be secured and a possible reduction of costs (those which may be cut off without affecting the core business) should also be sought;
- The entrepreneur should avoid the excessive exposure of the company towards certain clients or suppliers. Otherwise, any contractual incidents with a major client/supplier may put the company at risk and in a serious (uncomfortable) business situation, which might affect the transaction;
- The entrepreneur has to prepare the key employees who are likely to be maintained by a prospective purchaser. This means securing their employment rights and even attempting to incentivize them to stay with the company. Some of the key employees must also be prepared for the exit and informed on a need-to-know basis by the entrepreneur to this end;
- The entrepreneur may prepare a Business Plan concerning the prospects of the company as well as an Information Memorandum that reflects the situation of the company and lists possible things that may be improved. These documents are not mandatory, but, nevertheless, their existence would likely facilitate the understanding of a potential purchaser and, as a consequence, this may speed up the decision to acquire the business;
- Last but not least, the entrepreneur should consider to retain a team of trusted advisors on technical (if the case), financial and legal aspects pertaining to the future transaction. An early selection and a good chemistry with such team may be key to a successful transaction for the entrepreneur.
While all of the above actions would be likely to strengthen the entrepreneur’s position in case of a possible exit, there are also some actions, which, to a certain extent, should be avoided by entrepreneurs. Here are some insights regarding what not to do (the so called “don’ts”) in case an entrepreneur initiates discussions on a potential exit or such process is already ongoing:
- Hiding relevant information regarding the company from the outset or during the due diligence process. This course of action might negatively affect the purchaser’s trust and could endanger the acquisition of the company. Moreover, some of the information hidden during the process may emerge after the closing of the transaction which may trigger the liability of the relevant entrepreneur;
- Deciding upon certain actions which may have significant or even huge impact on the financial status of the company, such as: (i) distribution of outstanding dividends which were not collected for years back; (ii) laying off some of the key employees, otherwise important for the business of the company; or (iii) exposing the company towards one or a couple of clients by concluding easy to terminate contracts;
- In case the potential purchaser proposes to take over the business through a partnership with the entrepreneur, the latter should avoid corporate structures of 50/50%, as such mechanism may potentially lead to corporate blockage. Therefore, an exit mechanism should be included within the transaction documents (call/put option, drag/tag alone, etc.) so that the entrepreneur may have the comfort that he/she will not be easily removed afterwards by the purchaser and most importantly, without a proper compensation;
- Likewise, in the event the entrepreneur chooses to stay in the company after the acquisition, as a minority shareholder, he/she should pay a close attention to the exit clauses included in the transaction documents. From our experience, exit clauses fairly and firmly negotiated early on may be useful when the entrepreneur decides on a total exit later on.
As a final point of discussion, we would mention that one of the main questions we are frequently asked, from a business and legal perspective, is when the initial investor should make the exit decision so that he/she may maximize the outcome of the transaction. Analyzing the situation strictly from our legal perspective, the ideal scenario appears to be that in which the investor makes the exit when the target company is at its peak, from a business standpoint. In such scenario, the investor is in the position to be “bought” rather than “sold”, meaning that the investor has a good negotiation leverage, as the purchaser is keen to acquire the business.
Likewise, some transactions also turned out to be successful when the investor negotiated to remain in the ownership of his/her former company, as a minority shareholder and in a managerial position, and to support the purchaser during the transition period and, furthermore, to develop and grow the business. However, this approach has its flip side, as the former entrepreneur will have to embrace the culture of the acquirer and to accept certain performance criteria pertaining to the business of the target company.