The earlier you plan for your exit the higher the chance of successfully scaling and positioning the company for a lucrative sale.
I’m often asked when an exit strategy should be created. In an ideal world, it would be done in conjunction with the business plan. Entrepreneurs, however, tend to myopically focus on cash, acquiring customers, and really just getting to the point where the company is sustainable. They think, “Why plan today for what can easily put off until tomorrow?” This is a mistake.
An exit strategy is simply good business strategy.
An exit plan aligns an owner’s business, financial, and personal goals and is a living document, so it is continuously revised as the business scales. It serves as a guide for the business owner as they prioritize critical decisions to scale the company. This ensures that as the company grows transferable value is increased and the business will attract investors when they go to market.
The first step is understanding the value of your business.
An exit plan begins with a proper valuation which requires a quantitative and qualitative analysis. It is not an instance where you apply a capitalization rate to the net operating income, like real estate, and value can be quickly determined. A business is very different in that it consists of tangible and intangible assets that create future cash flow that provides a buyer with their return on their investment, therefore a mergers and acquisitions valuation must address both asset classes.
Not only will a valuation provide the owner with a range of current market value but it will also uncover weaknesses in the business that need to be shored up to ensure growth and future marketability. The most lucrative exits are businesses that understood the value as they were growing so they were confident their decisions were consistently increasing value in an efficient manner.
For example, we had a technology company that had a significant hole in their management team and a high level of customer concentration. These weaknesses proved to be a significant drag on value which limited the business’s marketability. They had to wait to go to market until they could implement their strategy to identify new talent, hire, train, and develop a process to retain them. Your management team and employees are one of the most significant intangible assets you have, now more than ever in our tight labor market. This client also had a significant customer concentration which can render a business completely unsellable. Investors often cite the 15% rule –they don’t want to invest in a business with more than 15% of revenue coming from the top three customers as it is most often considered too risky. Diversifying a customer base takes time, sort of like moving a tanker, so you don’t want to make this mistake.
Continuously valuing the business as it grows is critical to being able to properly scale your business in a meaningful way that will drive value and ultimately position the business to attract multiple buyers upon exit.
Your exit plan will identify changes that need to be made well in advance, such as the development of management, reducing customer concentration or removing dependency upon the owner. Another common reason for failure or stymied growth is a lack of capital. An exit plan will direct an owner to address any future financial shortfall that could prohibit scalability.
The exit planning process will often provide clarity as to what type of buyer will best fulfill the owner’s business, personal and financial goals and how the business will need to be positioned to fulfill that strategy.
For example, if the exit strategy for the owner is a transition to family, the owner will need to focus on the proper development of the next generation’s skills. This typically takes many years to accomplish.
At Legacy Partners we guide owners through an analysis to determine if an exit to the next generation can be successful and if not, how the exit strategy can pivot to accommodate a viable transition. For example, to solve skill development and financial concerns we have strategized to sell the business via a recapitalization in which the owner sells 100% of the business to a financial buyer and then at close buys back an equity position. The equity roll is typically a minority position that the next generation can retain while providing liquidity for the exiting generation. An added benefit to this structure is the investor will bring expertise that can help further develop the next generation’s skills.
An exit plan also provides a forecast of the potential financial impact to your personal wealth upon exit. Extensive financial planning is required to ensure taxes mitigation strategies are developed and executed prior to the liquidity event.
The plan also guides the owner in establishing their post-ownership goals to ensure they continue to live a purposeful life. It is a comprehensive plan that addresses all aspects of an entrepreneur’s life.
In order to realize a successful and lucrative exit, it’s best to plan your strategy well in advance and continuously update as the company scales.
An exit plan is a living, breathing, document.
Be sure you are giving your business oxygen as it grows and you too can enjoy a highly lucrative event that transitions your business from equity to liquidity to legacy.