As a business owner, you’re not going to work forever. You certainly will not live forever. No matter how far into the future it may seem, or how uncomfortable the question is, it’s never too early to start thinking about succession and exit planning.
Exit planning helps business owners to deal with the issue and develop a solution that’s right for them as well as the company.
Exit Planning Is Too Important to Ignore
One of the hardest decisions facing a business owner is when and how to exit the firm.
How to exit is an important issue not just when you’re beginning to wind down, but even in the early days of starting up the firm. The way you deal with this issue impacts many other key decisions made along the way.
The earlier you start thinking about the kind of exit that is best for you, the more time you have to make adjustments to your exit plan as a result of changing conditions and new personal goals.
Unfortunately, many owners do not conduct any exit planning. This makes the situation difficult when you’re forced to make a decision hastily when time starts running out.
Selecting the right exit is important because the implications for the company and the potential legal and tax liabilities are rather significant. Every exit scenario has its pros and cons. Good exit planning helps you to identify and evaluate these advantages and disadvantages.
What Are Your Options?
There is no single best exit strategy. Each business owner is different in terms of their individual goals. The right exit strategy is the one that’s good for the business and that aligns with the owner’s personal and professional objectives.
First, you must decide what you want from the separation from the business. Is it cash, management control, or intellectual property?
Also, you should reflect on why the company was started in the first place. Is it a lifestyle business where you basically created your own job? In that case, if you sell the company, you’re out of a job.
Or, do you see the business as a wealth generator, an asset to be sold for profit at the right time? The proceeds from the sale can be used to fund your retirement or to start a new venture.
Sometimes an owner simply decides that enough is enough. They call it quits, turn off the lights, close the doors, and walk away.
This involves liquidation, the selling of all assets. To make any money from the liquidation, a business must have valuable assets to sell. For example, buildings, equipment, inventory, and land.
In business liquidation, the money from the asset sale must first be used to pay off creditors and any outstanding taxes. The remaining money is then divided among the owners, shareholders, and partners.
Keep in mind that if you decide to sell the firm, instead of liquidating, you’ll be able to recover any market value that the business may have. The name of the business, the brand, may have some value, so it could be continued by the new owners. If a business has been around for a long time, there may be a substantial amount of goodwill. Walking away from that business could mean leaving a lot of money on the table.
Also, you’re not just walking away from the business but also from customers and employees. What is going to happen to them when you’re closing the door?
Family-Business Succession Planning
In many family businesses, the owner wants another member of the family to take over. This keeps the family legacy alive.
However, be aware that few family businesses survive beyond the first generation. Even fewer survive the third generation. Clearly, thinking that the business will stay in the family is a risky assumption.
The lack of a succession plan is the main cause of the poor survival rate of family businesses. Only a very small percentage of family businesses take the necessary steps to prepare for a smooth leadership transition.
Creating a succession plan for a family business is a complex process that can’t begin soon enough. It involves dealing not only with business issues but also with the sensitive and emotional relationships between family members on a professional as well as personal level.
It’s highly recommended to engage a consultant with experience working with family businesses to guide the family through the process. The consultant uses their expertise to avoid pitfalls and create an outcome that’s agreeable to all parties. In addition, they can be helpful with resolving the conflicts that invariably occur.
The legal and tax implications of a family business transition can be significant. Consequently, proper succession planning should not be conducted without the assistance of legal and tax accounting professionals.
Who should take over?
A key question in family business transition is who should take over? This could be a family member already working in the business. Or a family member currently working at another firm, perhaps even another industry, who has the skills, experience, and interest to head up the firm.
It’s important to pass the baton on to the most qualified person. Clearly, this is best for the business, and, ultimately, the family. Of course, this may mean that an “heir-apparent” with lesser qualifications is bypassed in favor of someone better qualified. It is these situations that create tense conflicts within the family.
With that in mind, you need to resist the temptation of keeping the business within the family at all costs. If no qualified family member can be found to run the business, you should seriously consider appointing or hiring someone from outside the family. Selling the business also becomes an option in this case.
Selling Your Business
Putting the business on the market
Offering the firm for sale on the market is the most popular exit strategy for business owners.
A key to success is to target the potential buyer in advance, positioning the business accordingly, and convincing the acquirer that the company is worth the asking price.
Unfortunately, it has been estimated that 75% of US firms are not able to find a suitable buyer.
Because of the complexities, it’s is a good idea to work with a business broker with experience in your industry. The broker will market the business that’s for sale, find interested, qualified buyers, and present the company in the best possible way. This can significantly improve the chances of success of the buy-sell transaction.
Confidentiality is another reason for working with a business broker. A good business broker makes sure that all communications and interactions with potential buyers are conducted with a high degree of confidentiality. This prevents tipping off competitors or, for that matter, anybody else who is not directly involved in the sale.
Selling your business to employees
Another option to consider in exit planning is selling your business to employees.
An employee buyout can be a clear win-win. The employees get an established business that they already know. You get buyers who want the business to thrive.
A buyout by the employees is usually accomplished through an employee stock option plan (ESOP).
In almost every case, ESOPs are a contribution to the employee, not an employee purchase. An ESOP is a kind of employee benefit plan, similar to a profit-sharing plan. In an ESOP, a company sets up a trust fund. The company contributions to this trust fund are then used to buy back shares from the current owner.
Setting up an ESOP is complex. It is a good idea to work with an ESOP consultant to structure the program and avoid any pitfalls. If an ESOP exit strategy is not appealing or the business is not eligible to have an ESOP, perhaps a key employee could take over the company.
Which Kind of Buyer Is Right for You?
It’s important to distinguish two different types of potential buyers: the strategic buyer and the financial buyer. Each with their own objectives and criteria for selecting, targeting, and buying another firm.
A strategic buyer is interested in how the new firm fits within their long-term strategy. There may be different reasons for acquiring a company, such as vertical integration, expansion, eliminating a competitor, or improving the competitive position.
The primary objective is to acquire a business whose products and services can be absorbed into the existing operations.
Often, a strategic buyer is willing to pay more for a target company than a financial buyer. This is because of the expected synergies and economies of scale from integrated operations. The better the new business fits into the existing company’s structure, the more a strategic buyer will want the business and the higher the premium they’re willing to pay.
Strategic buyers are usually larger and more established companies with access to capital for funding the acquisition.
On the other hand, a financial buyer makes an investment in a company to realize considerable returns from it within a relatively short period of time.
Typical financial buyers are private equity firms that leverage debt to realize significant financial returns. A financial buyer is always looking for companies with strong earnings, a solid balance sheet, and great growth potential. Sophisticated financial buyers will want to do a discounted cash flow analysis (DCF) to determine if a company is a good acquisition target. Usually, they want to see a return on investment in five to seven years.
A financial buyer sees the acquisition as an investment. They expect the investment to generate a satisfactory return. The financial buyer typically invests in a diversified portfolio of different businesses rather than only in those that align with existing operations. They buy and sell companies similar to how an investor might trade stocks and bonds.
Once the financial buyer achieves the target return from the investment, they’re likely to exit again. Either through an IPO or by putting it on the market once more.
What Is Your Business Worth?
If a business is not valuable, you can’t expect it to generate much interest from potential buyers.
What makes a business attractive? A solid history of revenue growth and profitability, a large and loyal customer base, a solid brand, a competitive advantage such as technology, opportunities for growth, and a skilled workforce, to name a few.
Regardless of where they are with regard to exit planning, few business owners know what their firm is actually worth. When was the last time you had a valuation done?
Most owners are quite disappointed when they get that first report. They expected their business to be worth more than it actually is.
If you’re in hurry to exit, there’s not much you can do. There may be ways to quickly cut some expenses to improve the valuation, but clearly, you’re running out of time.
However, if your exit is still years down the road, you have the time to grow the business to boost its value. This is another reason why you should start exit planning sooner rather than later.
There’s another advantage to improving the business performance. When you’re negotiating with a potential buyer you want to do so from a position of strength, not weakness.
Can the business run without you?
Another aspect that impacts the value of the business is how dependent the organization is on the owner. If the owner is the sole decision-maker with all the experience and know-how, then the business becomes much less valuable after the owner leaves. If the employees who remain on board lack the knowledge and experience to run the business then what is the new owner buying?
In simple terms, if the business is too reliant on your active involvement, selling the business is not going to be easy. The goal is to reap the benefits of your hard work and step away, not to continue your job under new management.
Take an honest look at your role in the organization. Are you micro-managing your employees or do they have a well-defined scope of authority? Are you delegating or are you trying to do everything yourself?
Just like you need to make strategic and operational changes to grow the business and improve what it’s worth, you’re going to have to change your role in the organization. This may involve more delegating, and training and coaching your employees to prepare them for their future roles.
Improve your business valuation
The sooner you get a baseline valuation, the sooner you can start working on growing the business and increasing the value of the firm to the target numbers you have in mind.
In most cases, there are relatively quick, short-term steps for improving the valuation. A professional business valuation consultant can advise you on what can be done to quickly improve sales and cut expenses.
But, if the gap between your target and the current valuation is large, you will have to think long-term. Growing the business requires a back-to-basics approach that involves strategic planning and creating effective marketing strategies. It’s a good idea to work with a business consultant who can offer advice and conduct research to determine what the best opportunities are and how to make it happen.
With this in mind, you should start exit planning at least three to five years in advance, preferably even longer. The more time you allow yourself, the more opportunities you have to improve the business.
Develop a solid business plan
A potential buyer will want to review your business plan. You need to show how you’re going to increase revenue in the coming years, as well as customer lists, product roadmap, marketing strategies, cash flow, and how you have achieved your current levels of profitability.
Legal and Tax Implications of Your Exit Strategy
Every exit strategy has its own specific legal and tax consequences. Make sure you are educated about their impact on the business and your personal finances and obligations.
After learning about the legal and tax aspects of your initial exit strategy it may very well be that another exit strategy is a more attractive option.
As soon as you start thinking about an exit, consult with your attorney and tax specialist. They can help you identify the best option for your situation.
Don’t Delay – It’s Never Too Early for Exit Planning
It’s never too early to develop an exit strategy that is right for you, the other stakeholders, the employees, and the business itself. The worst exit strategy is not having one.
If you need help with the exit planning process and formulating your personal vision of “what’s next”, there are consultants who can help in areas such as business valuation, succession planning, business performance improvement, strategic planning, marketing strategies, legal and tax issues, and so on.
And once you have made a decision about the right exit strategy, make sure that you start working towards putting the strategy into action, sooner rather than later.