Specificity is key when considering strategic options

Judging by the number of inquiries we receive on a weekly basis, one of the hottest topics these days in the boardrooms of employee- and ESOP-owned firms is the examination of the “Strategic Options” available to create and/or maximize shareholder value. More often than not, this is a serious exercise for these teams to assess whether the current leadership teams and majority shareholder groups want to and/or are able to transition their firms to a next generation of leaders and owners. (Let’s call this the “Transition Option.”) Most often, this strategic option is being compared to the competing options of selling the firm to a third party (“Sale Option”) or recapitalization of the firm with outside equity (“Recap Option”).

Trends collide: Why is this a top-of-mind topic for so many leadership teams headed into the back half of 2022? Essentially, it stems from the collision of two major trends that have been roiling the industry for the past decade. The first of these trends—which is rapidly coming to an end—is the imminent retirement of the balance of baby boomer owners and leaders from their firms. Scanning the industry, this dwindling group still holds significant ownership in their firms, and in most cases their ownership is disproportionate to the value they create. The second trend—which may be coming to an end after 20 years—is the availability of cheap financing for investors to acquire equity in these firms. Increasing interest rates are already throwing a wrench in the plans of a number of smaller private equity groups that have been considering investments in the AE industry.

Driven to decide: The impetus for leadership teams to invest their limited time and resources to examine their strategic options varies. Some are concerned about the ability of their existing stock repurchase models to support the buyouts of departing shareholders at a time of record valuations. Others are waking up to the fact that they’ve likely deferred succession planning five years too long, while still others have received offers from strategic acquirers or investors and feel compelled (or are required by charter) to seriously analyze the overtures.

What’s love got to do with it? Before a team can objectively assess its strategic options, it has to take emotion out of the equation. This is for many an unanticipated—but very real—challenge to sound, objective decision-making. There is an understandable and risky bias on the part of most teams to favor the “steady as she goes” with the current business model. “Understandable” because of inertia, familiarity, loyalty, fear of change, contentment. “Risky” because choosing the status quo based on bias has significant potential to actually destroy shareholder value in the future—particularly if teams delude themselves about their own leadership and management competencies (happens more than you think). The greater the emotion and bias in the decision-making process, the less optimal the outcome.

Comparing apples to various other fruits: One of the biggest challenges teams face when comparing strategic options is comparing the economic value (underline added for emphasis) created by transitioning the business to a next generation of owners and leaders to the economic value created via a sale or recapitalization. At the heart of the matter is comparing value created over an extended period of time (Transition Option) to value created at a single point in time (Sale or Recap Options). This is where specificity is your friend.

Specify success: It’s critical to specify a point of time in the future (one, three, five, seven, and ten years are all viable milestones) that connects with the definition of a successful Transition Option. (Let’s call this point in time “Touchdown.”) It’s also important to specify what “success” is in this Transition Option. For example, success could mean that 100% of key leadership and management positions have been transitioned in three years and certain key financial metrics (revenues, profits, backlogs) have been achieved to secure the capital model. These financial metrics can then be converted to a firm value. This value can then be compared to the estimated value of a firm sale or recapitalization at any point in time along the way to Touchdown. The delta between the economic value in a firm sale or recap can then be compared (with some time value of money thrown in) objectively. The team can then assess how the shareholder value resulting from a firm sale or recapitalization compares to the value created through transition.

Leaving money on the table: A sober objective analysis of the economics of their strategic options allows leadership teams to then reconnect with their emotions and biases—as is their prerogative. They can choose to “leave money on the table” should a sale or recap point to greater value if they see beyond the pure economic value of the options assessment or believe that remaining in control and transitioning the business results in a different and more fulfilling set of benefits for employees, clients, and shareholders.

Morrissey Goodale is a CFE Media content partner.

Original content can be found at Morrissey Goodale.

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