According to the Exit Planning Institute, 50% of all privately held businesses will be forced to exit under duress.
One of the five Ds that can kill a business will take it down: Death, Disability, partner Disagreement, Disruption, or Divorce. And, unfortunately, an unplanned exit will make it very hard to meet your business, financial, and personal goals.
You have spent too much time, energy, and capital building your business to let it perish without receiving a proper return on your investment.
Be prepared, develop an exit plan, and you will go from equity to liquidity on your own terms and preserve your wealth.
An exit plan begins with having a crystal-clear vision of what your ultimate goal is with owning a business.
What does the end of your business look like?
The majority of privately held businesses grow over several years or decades. An entrepreneur will start a business ground up based on pure innovation, or they may buy or inherit a business. The owner launches, grows the business to create income and security for themselves and their families, and eventually every owner will exit.
That, in a nutshell, is the life cycle of a business.
Having a vision of what your exit goals are as early as possible will dramatically increase your chances for a successful transition.
Let’s begin with what are your expectations for the business?
Are you building a life-style business meant to generate a nice life and cash to support your family? Has the business been in the family for generations and the expectation is the business will go on to the next generation?
Are you building a rock star business that has a growth trajectory shooting to the stars and you would like to take the business public and be the next Amazon or Apple?
Perhaps you have key employees that would like to share ownership of the company you have built.
Maybe you have imagined selling the business and getting a big pay out at the end of the day.
Or, you simply have had a lot of fun with the business, taken out some cash, and then shutter it.
There are 6 primary exit strategies, so let’s take a look at each exit option and weigh the pros and cons. Which exit will meet your business, financial, and personal goals?
- Family Succession:
Transitioning a business from one generation to another sounds simple. Easy, just get Jim Bob or Susie Lou into the business, train them, and then skirt out the back door. Right? Wrong! No other exit strategy brings out high emotions more than a family transition. And really, think about it: is your family sane?
Not always easy, but some family successions do succeed.
- You are keeping the family jewels in the family. A family member is more apt to keep the business running just as you like it and this strategy keeps the money in the family.
- It fulfills any family legacy promised. If the business has been in the family for multiple generations there is an implied expectation that the next generation is handed the golden egg.
- The transition can be quicker. Due diligence will most likely be shorter since you don’t have to deal with a pesky outside buyer.
- The failure rate is dismal. Studies show that less than one third of family businesses survive the transition from first generation to second and the statistics beyond the second generation are even worse. There are many reasons for the failure: lack of passion, misalignment of skill set, inability to be agile in the face of a dynamic economic environment, or the previous generation just can’t let go. In addition, families tend to be rooted in tradition and often subscribe to the philosophy that what worked for past generations will continue to work today. This ideology often proves to be a nail in the coffin.
- You may be tied to the business forever. The next generation generally does not have the money to buy the parent’s business and so most often there will be a note as payment. Get ready for Thanksgiving dinners to include questions about the business and if times get tough your note may be the last to get paid.
- Inability to create an equal distribution of assets between children. Passing the business down is an emotional decision for parents and of course every parent believes that they treat and love each child equally. The catch is that what is equal is subjective in the eyes of the children and this can cause the next generation to go to war.
Businesses that have been handed down through generations are successful because the hand down begins many years before the actual transition occurs. Enormous planning ensures the next generation is prepared to run the business.
If your exit strategy is succession within the family ask yourself the following pivotal questions:
- Is the next generation passionate about the business?
- Do they have the necessary skill set to grow the business successfully?
- Are you financially and emotionally prepared to pass the business down?
- Initial Public Offering (IPO):
You have worked hard building your business and you have capitalized the business with a bootstrap strategy. You relied on money saved, credit cards, friends and family, and any other way you could dig up a penny. The business has made it through the dangerous early stages and is officially off the ground and now is a proven business model. The business has grown with the resources available and research shows that there is indeed immense growth potential if only there was capital available to fuel the expansion.
Going public is sexy, gets press and is exciting but there are a few pros and cons to this exit strategy:
- Capital is raised to support the growth. Now the sky is the limit, or at least the growth potential can be realized to the extent of the capital raised.
- It is really “cool” to say your business went public. A big sexy feather in the cap of an entrepreneur.
- Success breeds success. There is only one coming out party and if you are successful it only gets easier to raise more capital.
- It’s expensive. On average twenty-five to forty percent of the capital raised will go to the very cost of the IPO.
- Now you’ve got demanding shareholders and perhaps an even more demanding board of directors.
- Extensive reporting. Welcome to the world of dealing with the security exchange committee (SEC).
- If the vision for your business includes a BHAG (big hairy audacious goal) to exit via an IPO how do you know it will be successful? You don’t.
But you may want to consider the following:
- Are you ready to give up equity and do you have a compelling case to go public?
- Is the idea of having board members appealing?
- Do you have the right team in place that are prepared for the rigorous financial reporting required?
- Employee Stock Ownership Program (ESOP) or a Management Buy Out (MBO):
Perhaps you have grown your business and feel that your employees and managers have been critical to your success and you would like to reward them by selling them the business either directly to the manager or through the establishment of an ESOP. ESOPs are a tax-qualified defined contribution retirement plan or more simply put they are trusts that buy, hold, and sell stock for the benefit of the employees. A management buyout (MBO) is a sale to the managers.
Good idea or bad idea? It depends.
- If you feel that your employees and management team have the right skill set and that they can continue to lead and grow the business this can be a viable transition. It has been proven that employee ownership is a strong motivator that drives success. In addition, the wish to carry on the brand identity or your legacy is traditionally fulfilled with these two exit strategies.
- The tax advantages for an ESOP can be significant. A MBO transition tends to be relatively smooth.
- If the mergers & acquisition market is in a buyer cycle an independent valuation that is utilized to set the selling price will most likely outperform an open market price.
- The sale to employees or the management team typically will add debt to the balance sheet as they borrow money to fund the ESOP or leverage the MBO. Also, when an employee departs the ESOP is required to buy back the shares.
- Setting up an ESOP is expensive and once established requires ongoing cost to administer the plan and adhere to the rigorous reporting required under the Sarbanes-Oxley act.
- If the mergers & acquisition market is in a seller’s cycle the valuation used to set the price may underperform the open market meaning if you sold on the open market you would most likely garner a higher price from a strategic buyer.
A few thoughts when considering a sale to employees:
- Does your leadership team have the skills necessary to grow the business and ensure continued success?
- Have you considered the tax implications and extensive reporting requirements?
- Are you as the owner prepared to give up some or all control of the company?
- Private Equity Recapitalization:
You have built your business to the highest level you can based on your capital availability and expertise. You know that your business has the potential to grow exponentially if you had the resources. A recapitalization in its most simplistic form is a partial sale. A private equity group, private investment group, or family office group becomes a financial investor in your business bringing both capital and expertise to the table.
When I owned my marketing company I knew that there was a tremendous opportunity to grow the company through a franchise strategy but did not have the capital or knowledge as to how to execute a franchise model. A sale to a financial buyer like a private equity group was an option to fulfill that growth strategy.
- A financial investor’s goal is to double a business in two to three years, triple in three to five years and quintuplet in seven to ten years. Ultimately the investor’s exit strategy will be to sell the business or take it public providing the business owner with two bites of the apple.
- A partial sale gives the owner some liquidity while maintaining an equity position. In addition, a partial sale spreads the risk; the business owner no longer carries 100% of the risk burden.
If you have a partner who wants to leave the business and you want to stay in the business, a partial sale is a good strategy to satisfy both goals.
- You no longer have 100% control over the business.
- Financial investors like to know what is going on with the business they invest in so you can expect lots of reporting to your new partner.
- There may be expected financial distributions to the investor irrespective of the business performance level.
Is a recapitalization right for you?
- Is your main objective to attract capital and expertise to fuel future growth?
- Are you prepared to give up a portion of equity and control?
- Do you understand the financial implications?
- Closing the Business:
Many a privately held business has met its demise via shuttering. Whether purposefully, or by force, such as an illness impeding an owner’s ability to run the business, simply closing the doors happens.
- It is relatively easy and quick to do.
- The timing of the transition is whenever it feels right to you.
- No future risk from any contingent liabilities.
- There is no big payoff for building the business.
- The legacy you have built with your business vanishes.
- Employees may be less than thrilled.
Is closing the doors your best option?
- Do you really want the value of your company to circle the drain? Your intangible assets such as your customer list, reputation, employees, etc. vanish in a liquidation with no return to you.
- Is your return on investment expectation just the market value of your liquidated assets?
- Are you satisfied with the disappearance of any legacy?
- Sale to a Third Party:
The majority of privately held business owners will exit their business via a sale to a third party. Buyers will be attracted to the business because they see value that can be capitalized upon so a sale on the open market often garners an attractive return on investment.
A third party sale is a liquidity event that if done correctly will preserve your wealth for generations to come. Remember, always run your business as if you will run it forever, but be prepared to sell it tomorrow. Recognize that income from a business is fleeting whereas wealth is eternal.
- Enables the owner to transition from equity to liquidity thus preserving wealth. A sale to a third party through a controlled auction on the open market will ensure that you get the highest return on the investment you made in building the business.
- A deal can be structured so as to protect employees and could allow you to remain active in the business.
- Takes away the risk of owning a business. When we first start out we are more risk tolerant but as we become more successful and amass more assets our risk tolerance often declines.
- A successful sale requires extensive planning and takes time.
- Market timing is an important aspect of selling your business successfully and the business owner does not control the mergers and acquisition economic cycle. If it is a good time to sell a business, premiums are paid and if we are in a down cycle, businesses can sell for pennies on the dollar.
- Post close of the sale the business owner may be constrained from working in the industry because of a non-compete agreement.
Is an outright sale of your business the right exit strategy? Consider the following:
- Is your business positioned to attract buyers?
- Are you financially prepared to transition out of the business?
- Are you personally prepared to leave your business?
We’ll explore these questions in the next few newsletters…stay tuned.