What is a pre-exit and why should a business owner consider it?

Whilst the term may not be as well known in other geographies as yet, the principle will be common to many in the industry as a private equity or partial sale. But thinking about it as a pre-exit may appeal to a lot of owners, who might fear that the prospect of selling means losing the opportunity to create future value. 

What does pre-exit mean?

With a pre-exit, an owner doesn’t sell their business in its entirety. Instead, they keep a minority or majority stake in it and sell the rest.

This arrangement stays in place for an agreed period, aligning with the hold period of the private equity house, which can typically vary from three to seven years. Once this period ends, they can usually look to dispose of the retained stake fully to its new owner. However, before this, during the pre-exit period, they would stay actively involved with the company.

A private equity sale of a business allows an owner to transform the company into an investment opportunity and bring on board a supportive partner to facilitate further growth.

It's a quid pro quo. They sell part of the business. In return, they attract investment that grows its value when the original owner comes to complete the transfer and hand over the remainder.

An owner stays involved while the acquirer helps them build value in the business. Pre-exit is an intermediate step but also potentially a highly lucrative one.

Why are business owners more interested in pre-exits?

Previously, where business owners might have seen trade deals as an ideal, no-nonsense solution to selling up, now they are more aware of challenging market conditions and what it takes to overcome them.

Maximising the yield from selling a business takes a long-term strategy. Of course, serial entrepreneurs have always known this, but private equity is changing the thinking and approach of more and more business owners. Business owners are finding that they can optimise their operations, enhance performance, and grow their enterprises. In effect, they transform their businesses before wholly selling them.

The owner can still be part of the business but work less, should they choose, reaping the rewards of their hard work sooner. Finally, as their capital is no longer fully tied up in the company, they can spread their risk. 

Private equity is in a stronger position to compete because, simply put, there is still a lot of money out there. Current investment dry powder is around USD 3.7 trillion globally. Investors are looking for ways to spend their money. Business owners are responding.

In the UK, Accountancy Daily reports that 20% of business owners are looking to sell to private equity – 11% plan to sell a minority stake, and 9% a majority stake.

Other external factors influence business owners to look to pre-exit as an answer. They may feel pressure to accelerate their exit plans to protect themselves against future changes that threaten to sabotage their sale.

One such change in the UK is a new party in government. The latest projected date for a UK general election is January 2025. Should Labour get in, there may be scope for alterations to capital gains tax (CGT), bringing it more into line with income tax. Currently, the shadow chancellor says there are no plans for this, but following the Office of Tax Simplification (OTS) review of CGT in 2020, the prospect of a change is rather more than less likely.

Other factors prompting business owners to consider selling earlier are obstacles to accessing capital and long-term investment. Many businesses report these difficulties. The paradox is that in choosing to begin part-selling their companies, business owners can start to attract interest and investment that otherwise could be conspicuously absent. 

How does a business benefit from a pre-exit?

Investors would typically only look to back a pre-exit where they are backing a growth trajectory. Greater investment means the company can attract more talent and address any knowledge or skills gaps. 

Furthermore, pre-exit can be less disruptive for employees, customers, and stakeholders because it builds a high degree of continuity. Ultimately, the injection of investor cash and expertise should ensure the company is stronger and more competitive when the complete sale goes through. In the run-up, pre-exit reduces the risk for the owner and shareholders by spreading it more evenly.

Jonny Parkinson is a Managing Partner with Marktlink and is passionate about driving increased cross-border activity into the UK M&A market. He has over 10 years’ experience at an international M&A firm where he successfully led almost 100 transactions, advising entrepreneurs looking to buy or sell in achieving their M&A goals. Jonny holds a degree from University of Nottingham and ICAEW’s CF qualification.