Just like how no landscape company is exactly the same as another, there is no one right exit strategy. If you are trying to determine which is the best fit for your organization, check out some of the common paths and the monetary implications of each.
Types of Exit Strategies
Mergers and acquisitions are one of the most frequently used exit strategies for landscape company owners. The third-party buyer could be another local business, a national brand looking to expand into your market or private equity.
“An owner needs to take into consideration factors that will make the business more attractive to typical business buyers, including growing revenue and profitability, avoiding customer concentrations, strong accounting records and building the business’s independence from the owner,” says Ron Edmonds, principal consultant with Principium Group, based in Memphis, Tennessee.
Tom Fochtman, CEO of Ceibass Venture Partners, based in Arvada, Colorado, adds you want to make sure your financial house is in order and your assets are current.
Converting the company to an Employee Stock Ownership Plan (ESOP) is another option, but this route is highly regulated. Edmonds says owners need to tailor their operating model to conform to the ESOP structure.
“For example, ESOP-owned landscape companies need to be liquid enough to handle the requirement to pay out participating employees when they leave the company,” Edmonds says. “With leveraged ESOPs the company needs to be able to predictably meet the debt service.”
Generational transactions or passing the business on to a few key employees may be more flexible, but they need to be structured to meet the needs of both parties.
“You don’t want to sell something they have to take time to fix,” Fochtman says. “They will be too busy with operations to be in fix-it mode.”
Edmonds notes that many business owners believe passing the business on to their children eliminates the need for planning, but this is not the case. In some cases, the next generation may not have the business acumen or drive to operate the business successfully. Other children might end up relocating to accommodate their spouse’s career.
“Unless you have a ‘Plan B,’ the later the business owner figures this out, the fewer options he or she will have,” Edmonds says.
Even if a generational transfer is the right choice for the business, you have to consider the economics of the sale.
“Will the next generation buy the business with third-party financing to unlock the retiring owner’s nest egg?” Edmonds says. “Will the old owner stay on the payroll to realize that value? How will management boundaries be enforced going forward? What happens if the business falters under the next generation’s leadership?”
Payment and Tax Considerations
Depending on your exit strategy route will greatly impact how you are paid out and what the tax implications will be.
With M&A transactions, Fochtman says if you have created a valuable company that is the best in class in your market, you will receive a high multiple of EBITDA at closing.
However, Fochtman notes many transactions today come with earnout clauses. Many may think they can sell the business and walk away after closing, but owners should stay through the earnout period. The concept is to ensure the EBITDA used at the time of purchase is intact a year later.
“A typical structure would be after year one, the same EBITDA has been produced,” Fochtman says. “After year two, there is a minimum of 8 – 10% growth in EBITDA. At closing, an amount of money is held back. Maybe 10 – 15%. After year one, if the EBITDA is reached, 50% of the holdback money is released. After year two, assuming the agreed-upon threshold has been achieved, the remaining monies are released. Conversely, if numbers are not achieved, that money is deducted from the holdback funds.”
Another oversight is not understanding the tax implications involved with the sale of the company.
“Most business sales are structured as asset sales for tax purposes,” Edmonds says. “For the most part, the federal income taxes from the sale will be capital gains, but certain parts of the transaction, including depreciation recapture on equipment, will give rise to ordinary income. State taxes may or may not be a significant favor.”
Fochtman says that most sellers want as much cash at close despite the tax ramifications.
“You also must balance what they will pay in taxes versus having the cash in various equities that are creating income,” Fochtman says. “If a seller can create income from whatever investment to offset the taxes created by the sale, it is much safer to be an all-cash seller.”
A seller should be willing to pay for the best accounting team to help with tax planning when selling the company.
Fochtman says when selling to a family member, an owner may be more willing to defer money they could receive at closing. The taxes associated with deferred payments will usually be deferred as well.
“In many cases, when a portion of the proceeds is deferred or unknown at closing, such as an earn-out, a seller note, or rollover equity, the transaction can be structured to defer taxes on the deferred portion until it is available to the seller,” Edmonds says.
For ESOPs, Edmonds says that they can have very different results because they may not be a tax-paying entity. In a few specific cases, ESOP transactions may result in near-total deferral of taxes.
