Business Articles

Exit Strategies for Business Owners.

by Mary Hanson

 

There are many reasons why a business owner should have a business plan.  One reason is to make sure all aspects of the business plan and business operations are consistent with one another.  One of those aspects is the “exit strategy.”

 

Whether you plan to run your business until you drop, or you plan to sell the business in a few years, your business plan needs to address your intended “exit” from the business.  If you haven’t even thought about your “exit strategy” your business plan is ignoring an important issue.

 

If you both own and operate a business, you must address the fact that you cannot run the business forever.  You need to anticipate your retirement, sale of the business, possible health or personal situations that would limit your ability to manage the business, and your death.  If you are not there to run the business, will the business still be able to operate?  Will the business have any value, or will all the value you have built up be lost?

 

You need to have a plan for your exit from the business, and the rest of your business plan needs to be “in sync” with your exit strategy. 

 

Some Exit Strategies

 

The traditional exit strategies are:

 

* Transfer of the business to the next generation; and

 

* Sale of the business upon the owner’s retirement or death, or sale when the business reaches a certain size.

 

Other less traditional pro-active approaches are becoming more popular.  Some of the increasingly common exit strategies include:

 

* Development of a business specifically for eventual sale to a particular potential acquirer.

 

* Bringing in outside management so that the business can operate with any owner, allowing the greatest range of alternatives (transfer to the next generation, sale to management, or sale to a third party).

 

* Bringing in additional owners with the intent that the new co-owners will eventually buy out the original owner.

 

* Merging two established businesses to achieve faster growth or diversification and to provide an exit to one of the parties to the merger.

 

Each type of exit strategy has its risks.  There are always a million ways to go wrong, but the risks and mistakes in exit strategy tend to group around two problems. One problem is not having an exit strategy that works with all the other goals, objectives, and operations of the business.  The other main problem is “the wrong people.”  Even if a plan is terrific, its successful implementation depends upon finding the right other parties to the arrangement. The “wrong people” can be management, key employees, buyers, or co-owners.  And the “wrong people” can be terrific people – just not the right people to implement the plan to meet the objectives of the business owner. 

 

This is where a written business plan can be so beneficial.  The written plan can be reviewed by the financial advisors, estate planning advisors, management consultants, and key employees.  Mistakes in planning, implementation, and selection of the right people can be avoided. 

 

Avoiding Mistakes

 

Consider the following examples of what NOT to do:

 

Don’t: Bring in an employee as a co-owner to eventually take over the whole business, unless the individual is committed to buying you out and has the financial ability to complete the purchase.  Once you bring in one person as a co-owner with the idea that he or she would buy you out, many other opportunities are lost.  If the individual does not have the management skill or capability, he or she can be the wrong person.  If he or she does not have the financial ability to buy you out, your plan to sell the business may never be accomplished.  If he or she is not ready to make a commitment and complete the purchase you are stuck waiting and negotiating.  If you have gone into the arrangement with an employee without a firm commitment regarding buyout terms, price, and timing, you are in a permanent negotiation to accomplish your goals.  And you are negotiating from a vulnerable position.

 

Once someone besides you owns part of your business, you cannot change your mind and adopt a different plan.  Even if you have a well-drafted buyout agreement that permits you to buy back that party’s stock in your company under certain circumstances, you will not be able to get back to where you would have been if you had not entered into an ill-advised arrangement. For one thing, “not working out” is hard to describe and generally does not trigger a right to buy back stock under a buyout agreement.  Secondly, even if you can get the stock back you typically have to pay a meaningful amount of money to get it back, and your exit strategy will have been set back significantly.  The time and effort spent with the wrong person could have been spent building up the business and/or establishing the right relationship with the right party (another key employee, an outside buyer, stronger management, members of the next generation, etc.).

 

Don’t:  Merge your business with another business as your exit strategy unless the other party actually buys your business or enters into a binding commitment to do so.  Once you have merged your firm into another firm, you no longer have any business to sell.  Your time to strategize is over, whether you have exited or not. 

 

Recommendation:  If you are merging two businesses (whether as part of an exit strategy or not), treat the transaction as a purchase and sale of one of the businesses.  Don’t let “our 2 businesses would be great together” overwhelm your need for a long term plan that makes sense for your objectives.

 

Recognizing the transaction as the sale of business raises questions that need to be raised.  Are you the buyer or the seller?  Do you really want to continue to work and work hard in managing the merged business?  For how long?  Does the other party plan to or need to continue working?  Does your agreement include a commitment for one of you to buy out the other party?  Does one party expect to be semi-retired (working a little bit but paid a lot?) in the merged business?  Can the business afford to lose the efforts of that owner?  Can the business afford to pay compensation for dead weight, if that is what happens?

 

If you are really the “buyer,” do you have the financial strength to meet all the commitments of the merged business? If you are really the “seller,” does the other party have that financial strength?   If things don’t work out, can the businesses be pulled apart?  Will separate identities, profit centers, or other aspects be maintained for some time so that there is some possibility of  “undoing” the merger?  Although doing so would be very difficult, the demise of the business would be worse for both parties. 

 

Don’t: Sell the business to an individual or company that does not have the financial strength to meet commitments to you.  If you can be happy if the business closes its doors within two years of your sale, then it may not matter.  If you have been paid in full at the time of the sale, you may or may not care about the difficulties of the buyer.  If, however, you are receiving payments on the purchase, consulting fees, rental income from leasing property to the buyer, you will regret not being more concerned about the financial strength and management strength of the buyer. 

 

Even if the closing of the business would not hurt you financially, you may be concerned about your employees, your customers, your distributors, or your reputation.  If your name is on the business or on products, you may regret that you did not entrust your business to a stronger buyer. 

 

Whether the buyer or buyers are the most wonderful people in the world should not be a consideration.  In the business world it is important to determine as well as possible whether the people and firms we do business with have the management capability and financial strength to help us achieve our goals. 

 

The greatest plan in the world depends upon capable implementation and adequate resources.  The greatest people in the world still need a coherent effective plan – and adequate resources.

 

Don’t: Plan to sell your business for a high price as a critical key to your financial ability to retire, but operate the business in a manner that makes your business unsaleable or saleable only at a low purchase price.  This is really a matter of good management planning rather that exit planning, but failure to have a good plan affects your ability to exit the business. 

 

Look for these management mistakes which can affect the saleability of a business: 

 

***

In the article I use the term “merger” to refer in general to the combining of two businesses.  The term “merger” in the legal and tax world has more specific meanings.  Under corporate law it refers to particular types of combinations of entities.  Under tax law it refers to particular types of combinations of entities with particular tax treatment (typically tax savings or tax deferral).  When truly “merging” two businesses under these laws, very specific requirements must be met.

 

This brings us to a more important point in business planning.  Any sale of a business has tax consequences.  Since the sale of a business can involve substantial sums of money, the taxes can be substantial.  Very very early on in your planning to exit the business, you need to consult your tax advisor to be certain you do not step into tax traps.  In making sure your exit strategy is consistent with other plans and objectives, review all the tax consequences as well.  

Copyright 2005.  Mary Hanson. All rights reserved.

Mary Hanson, MBA, Attorney at Law (310) 543-1355 Torrance (Los Angeles County), California USA