Making an Exit

Entrepreneurs and other small businesses often ask us why they need an exit strategy plan. Our simple answer: At one point or another, every business will transfer ownership, period. There is no way around it. The only question is, whenever it happens, will your business be ready?

Business owners don’t know if their businesses will be forced to transfer ownership in the blink of an eye, in a short-term process like selling a business or over the long term like transferring ownership to their children. Each of these situations has unique circumstances and characteristics that should be analyzed and evaluated, and a well-thought-out plan, or plans, should not be overlooked or left undone. Our industry has seen each of these scenarios play out, and your business shouldn’t be the next to transition without your plan being implemented.

Trying to develop your plan under a time crunch adds significant stress to the process and allows opportunities for mistakes to be made. This process can be one of the most emotional and challenging financial decisions a business owner can control. When it comes to developing the strategy, it is always best to be proactive and to take your time. That way, the plan can be implemented on your terms and on your time line.

Simply, an exit strategy is a plan put in place to define the "when" and "how" to transfer ownership. The plan outlines different scenarios or goals that, once met, would indicate you are ready to exit the business. Understanding and planning for an end to your business ownership allows you to make the appropriate day-to-day decisions within your business that will allow you the highest gain.

With the appropriate plan, a little luck regarding market conditions and your industry strength, you can turn your exit plan into reality on your terms or be ready for an opportunity that presents itself to you earlier than expected.

Because every business owner will someday need to transfer ownership, several factors can influence that decision. It may be age or health, retirement and estate planning, partner problems, family succession, financial considerations, operational issues, industry change or industry consolidation.

With these factors determining the course of action, the exit event can be realized via several options. You can transfer ownership to family, transfer ownership to employees, sell to an outside buyer, take the company public or, the least favorable option, run the business till death—either yours or the business’s (liquidation).

Within our practice, most of our clients set out a clear exit strategy plan. There is a mix between types of exits involving selling to family members, providing reward or ownership to employees or selling to maximize the business valuation to a third party.

The development of a plan must be focused on the specific objectives of the business owner. You must ask yourself what ultimately will bring the greatest reward:

We are sure to explain that the "reward" is not always financial or the equivalent of striking it ultra rich with a sale to a third party. But, if that is your goal:

In looking at your determining factors, your exit may involve financial considerations, time elements, key operations benchmarks, your workload or combinations of each.

Time. When considering time, you may know that you want to grow your business and operate it for five more years. You may set an age to retire or an age to step back and do less. Advanced timing is the prime example for well-thought-out plans. Are there steps you should take in each year leading up to the transition? Yes.

Workload. When analyzing workload, the business may have grown to a level that requires more of your time (or too much), more resources, more employees or simply more risk as the business grows. You may want to set an exit plan that allows you to take time off when needed and not always be strapped to the business’s daily operations.

Burn-out from running the business is a significant stressor that can cause you to cut corners or miss out on opportunities that could have been realized with a proper exit plan. Low barriers to entry, including operators shredding for a paycheck or undercutting prices, could dictate your desire to exit the market.

Financial. Financial considerations may involve a level at which the business requires additional investment to grow. You may already know that once a capital budget reaches a pre-determined number, you are unwilling or unable to put more cash into the business.

You also may know the specific amount of money someone would have to offer for you to sell. When starting the business, you may have had a goal of selling the business once you could get "your number." Warning! Your number must be realistic, or this scenario may never be achieved.

Operational Benchmarks. Operational benchmarks may be based on a specific revenue number or a certain operating profit level. You may incorporate benchmarks such as number of mobile trucks, tons of paper produced, customers served, number of physical locations or total number of employees.

Market Opportunities/Changes. Good or bad market conditions could surface that lead to exiting the business. Market changes could spark an exit if economic conditions continually deteriorate. Instead of riding the downfall to the bottom, you may choose to exit.

Alternatively, a buyer could come knocking, wanting to buy your business for a strategic purpose. The buyer may have targeted your market to enter and may choose to buy you (or a competitor), use its existing infrastructure to cross sell to its existing customers or maximize the synergies of a business combination. You can capitalize on the opportunity. The strategic buyer may be willing to "pay up" for your business to incentivize you to take its deal now rather than start from scratch.

Death. This is where the saying, "I’ll work until the day I die," actually has meaning. Simply put, your plan says you’ll transfer ownership upon your death. The plan should be documented prior to the actual event. You can’t plan the "when," but should definitely plan the "how."

Transfer to Family. Transferring ownership can be accomplished by selling or gifting ownership to a family member. A transfer valuation is negotiated and then the family member buys or is gifted ownership based on this plan. Tax ramifications and appropriate, approved valuation methods must be utilized so that there are no adverse consequences with the IRS or the estate. Many times, incremental gifting is the best option but also takes the most time.

A transfer to a family member is going to have the least financial reward to the owner, but may fulfill a family succession plan. This type of financial valuation falls at the lowest end. This type of transfer requires the most forethought to optimize the transfer.

Transfer to Employees. Transferring ownership to employees can be done with an outright sale to employees or an ESOP (employee stock ownership plan) and also can be done in one event or over time. This exit may reward certain employees for their commitment, incentivize them for their involvement and allow you to provide for those that helped you build the business. This option is going to have a slightly higher valuation than a sale or gift to a family member.

Sale to a Third Party. Transferring ownership to a third party is the most common exit. When it comes down to the honest assessment of reasons for an exit, most want to walk away with the highest valuation possible. A sale to a third party can take on several different scenarios. You can sell to a financial buyer (one buying the business for purely a financial investment), a strategic buyer (one wanting the business for a strategic purpose that adds value) or a competitive strategic buyer (a strategic buyer with specific competitive concerns). With each of these buyers, structure, terms and conditions of the transaction are just as important as overall purchase price. This type of exit falls in the mid to high category depending on current market conditions.

Public Offering. The glamour and buzz has always been to take a company public. With the financial reporting requirements, Sarbanes-Oxley and governmental regulations, the goal of taking a company public has gotten more difficult. The criteria that interest the professionals who take companies public, and who get the underwriters excited, are specific and difficult to achieve. This option is reserved for the best businesses of a significant scale and size with the appropriate allocated cost and capital associated with it. It can be done and can result in the highest valuation.

Estate Mandate. An estate mandate transfer occurs when you as the business owner pass away and your business becomes part of your estate. Hopefully you have the appropriate legal documents in place to direct traffic regarding your estate, but this avenue also results in all kinds of other issues to be left for the estate attorney, court and trustees. There also are specific valuation issues and taxation issues that could arise from this event should it not be documented properly before your actual death.

Liquidation. A liquidation situation is where the assets of the business are liquidated and the business has no real value as an on-going entity. This is the most basic exit. This also may be defined as "missing your exit" from a pure valuation standpoint. Other than purely unexpected or unanticipated events beyond your control, this liquidation approach is what you are trying to avoid by having a viable exit strategy.

The best exit strategy is one that fulfills your goals and objectives. If it is to achieve the highest valuation possible, then your potential exit may involve selling to a strategic buyer in a competitive situation or building a sizable business that could be taken public. If it involves a legacy for your business to continue, as is, then you may want to transfer ownership to your family or employees.

The exit plan that is best for you can only be determined by you and your advisors. That is why planning early and often can allow you to achieve the best-case scenario on your terms and conditions. It also will allow you to be ready should an opportunity arise unexpectedly. The time, effort and potential cost of putting together an exit strategy plan is minimal compared to the benefits of having the appropriate plan in place.

Serial entrepreneurs and investors often realize the importance of the exit plan because they have been there before. Often, once they have seen the nuances associated with exiting that business, they know that, "next time," they will understand the exit prior to getting into the business. You don’t have to go through it without a plan; your "next time" can be "this time." n