By Alex White, Associate Director, Equiteq.
Last week we looked at how it’s important to ensure that shareholders in the business are aligned before preparing for sale. This week we’re exploring why equity incentivizing your senior team can improve the equity value of the business.
The gold standard to successfully grow and realize maximum value in people dependent businesses requires a high degree of shareholder and management team alignment, as well as strong financial performance.
Awarding shares (or options) to the right people in the right proportions is one of the most powerful tools at the founding shareholders’ disposal. It’s not the only tool, but it is the most potent, which also makes it risky if applied badly.
There are 7 key areas to consider.
1. Get the timing right
To maximize value creation from equity dilution and incentives you ideally want to be at least two years away, or ideally longer, from your exit. If that’s not practical there is often still value in a shorter time frame.
The size of the business will also impact on the most appropriate option. Larger businesses will invariably have broader equity ownership and have professionalized management teams centrally and by service and/or sector lines. Reviewing the optimal equity structure and the ability to cash out individual shareholders from time to time to create room for the next generation is important for sustainable growth.
It’s essential to get expert advice on your strategic options set in the commercial context of what buyers now and in the future are looking for.
2. Invest your equity in the right people
The purpose of diluting equity is to grow value, so it’s critical to understand what the ideal ‘A Team’ for driving equity growth looks like, both the role and the individual. Incentivize your most important people in the top tier with higher-class shares.
3. Generate long term loyalty
Owner managers deliver continuous commitment and company performance improvement. Non-shareholding colleagues can be equally committed and loyal – but disruptive events do occur. It’s vital you reduce the risks of these ‘assets’ leaving the business at any stage in your exit strategy journey.
4. Align your exit strategy and objectives
If you want to sell 100% of your shares by a certain date or value, then it’s important that prospective or existing co-shareholders understand this and are working towards that goal as enthusiastic (or at least compliant) beneficiaries.
However you introduce and structure the shareholding, there must be emotional buy-in before, rather than after the fact. This can take some time and effort and is another area early engagement with external advisors can be helpful for objective advice.
5. Alignment with the company growth strategy
Alignment on exit value and timing is great, but opinions on the optimal route can differ. Do you want to open that new office? Do you want to invest in tech-enabled IP? These types of investments can be negative for short-term but positive for medium-term value growth and need to be aligned with shareholder timings and value objectives.
6. Improve transaction success
A strong, cohesive management team with skin in the game dramatically increases value and transaction success. A buyer that sees leadership and management succession in place will pay a higher value. And in a deal with earn-out terms where key managers own equity, buyers will pay higher value again. This is because acquisition risk is lower due to the critical team having a vested interest in the continuing growth of the business.
If key people participate in an earn-out, they’re more likely to stay the course and maximize their personal share value. This has a huge impact on the value achieved for all shareholders.
And when considering a sale to private equity, if the succession management team have equity to reinvest, this will be positive for the deal overall. It shows investors that management will share in risk and reward.
7. Get the share or options commercials right
The common basic concept is that new equity incentives pay a share of the increase in value of the company and they can be delivered in many different ways. While it’s essential to consider the tax efficient wrappers or commercial structures that achieve similar results, too many become consumed with tax issues alone.
The lions’ share of the advice you take on designing a scheme to increase value ought to be delivered by growth and transaction experts who advise on shareholder and business strategy. Those commercial advisors should also be experienced working with and around tax issues and managing tax advisors and lawyers. They will help you ask technical tax advisors the right questions at the right time.
Incentivizing senior members in the business is a complicated and potentially risky undertaking. But done correctly, it can fuel your consultancy’s equity growth.
Read more about why equity incentivizing your senior team can improve equity value in our longer article.
Or why not listen to Alex explain the importance of equity incentivizing your team in our webinar.
If you are thinking of selling your consulting firm and would like to discuss your plans, please get in touch.
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