Exit strategies are something that every business owner looks for at some stage of their life. Even if you are a small business owner, you need to decide how to leave your company. Just like any other investor, the questions are same when you think it’s time to move on. Questions like, how I’m going to get my money out of the business? And how much money I’m going to get? Having a sound exit strategy gives you control over your business’s future and answers these important questions. For any business owner there are a few options available. Let’s discuss them in detail.
1. Sell or transfer the business to a family member
For many business owners, selling or transferring the business to a family member is an ideal exit strategy. This allows them the ability to keep the business within the family and its members still benefits from the company. This process also gives the business owner the opportunity of limited tax liability by transferring the business interest as a gift during his or her lifetime. However, this strategy has some drawbacks, some family members may not want the responsibility of owning the business or others may prefer to operate it. This may cause a family feud.
Moreover, handing over the business to any family member certainly not provides the business owner enough capital to leave the business and live comfortably in retirement. For this reason, the owner may want to completely sell his or her business to a family member and get the full selling price. There will be no estate or gift tax on the sale as long as the business is purchased for its fair market value. There may be capital gains tax if the business is sold before the business owner dies. The business owner should plan carefully and conduct an evaluation whether a sale or a family transfer is best for the company. The business owner should also consider the family member’s skill set, age, desire to run the business and the reaction of key non-family employees.
2. Selling the business to trusted employees
Selling the business to one or more trusted employee is comparable to selling the business to a family member. This strategy will allow the owner to reward the trusted employee for his or her contribution to the company’s success or provide him or her successful business opportunity just like the business owner had. If the business market value is less than $2 million and an outside third party is hard to find, selling the company to a trusted employee is a good substitute. The problems of selling the business to a trusted employee are also similar, the employee may not have the capital to finance the sell or don’t want the responsibility of owning the business.
Read more: How to sell a business to key employees
3. Selling the business to Co-owners
The process of selling the business to co-owner is governed by an ownership agreement and different from selling to family or trusted employee. An ownership agreement contains certain restrictions, such as how and when the ownership will change, who will take over the business and the selling price. If ownership agreement exists, the co-owners have an RFR or right of first refusal to purchase the entire business before it sold to an outside third party. The advantage of selling to a co-owner is that he she is a known entity and already involved in the ownership of the business. The business owner knows the buyers skill set, knowledge and commitment to the business. A sale to a co-owner is a flexible process and owners can set up a gradual sale process or quick handover of the ownership.
4. Selling via ESOP or employee stock ownership plan
An ESOP is ideal for business with solid prospects, low debt and high-value employees. When selling via ESOP, the owner sells a trust to the employees. The process can work in two ways. First option, the company makes tax-deductible deposits in ESOP and the trust gradually purchases the owner’s shares. Second option, the ESOP can borrow funds from a bank and buy all the shares of the company. ESOP has a lot of advantages: flexibility regarding the sale, allows the business owner receives cash at closing, and a work force motivated by the ESOP.
However, an ESOP may not deliver the owner full sale price as some of his assets will be used as collateral to secure the loan and trusted employees may not get enough benefits to encourage them to stay with the company. Often an ESOP is very complex and expensive to set up and maintenance involves a lot of regulatory requirements. A prerequisite to an ESOP is that the business must be profitable enough to buy the owner out and presence of a solid management continuity plan.
5. Selling the business to an outside third party
Selling the business to an outside third party is ideal if the owner’s main objective behind the exit strategy is obtaining the highest amount of capital. Selling to an outside third party usually means selling the business to a larger public company. By selling to an outside third party, the company owner gets the highest purchase price possible, more cash at closing and no risky additional investment; however, in some cases smaller business may have to receive a promissory note instead of a cash-closing. This option allows the business owner to show his company’s worth to the potential third party buyer and negotiate.
An observant buyer will not calculate the value of any business solely on the income that the company generates. There are also disadvantages to selling the company to an outside third party. Selling to a third party puts the career of the employees at risk and mission and culture of the company vanishes over time. The good news for the business owner is he or she will be able to completely walk away from the business.
6. IPO or Initial public offering
For many business owners, the IPO is the ultimate exit strategy, because an IPO provides the business prestige, long-term capital, improved financial position and public awareness about the company. However, selling a business on the public market is complex, rare and often not a viable option, especially if the company doesn’t have a high stock market valuation. For an IPO, a very detailed report of all aspects, including staffing, operating, marketing, finances and management have to be created and for a small business, it’s a very expensive process.
Potential investors and analysts will take a close look at these reports and the company’s quarterly performance to determine the value of the stock. This process will keep the business owner busy with investors and analysts instead of running the business. An IPO also requires extensive record keeping. If the company finally goes the IPO route, the business owner is expected to lose control of the company.
7. Becoming a passive owner
A business owner may choose to become a passive owner in his or her business. This option will allow the owner to remain in control of his or her business, but business will be less dependent on him or her. This option attracts the business owners who want to start the selling process and want to observe how the business performs without the owner’s involvement in the day-to-day business. This process is a good foundation for handover to a family member or an outside third party sale.
By becoming a passive owner, the business owner can maintain the company’s mission and culture and at the same time minimize income loss. However, with this option, the business owner retains all risks associated with business ownership and receives very little extra cash when exiting the active employment status. For this process to work, the company must be organized in such a way that the company owner may become the passive owner without affecting the income generation of the business. And of course, the business owner must possess the ability to stay out of the day-to-day business.
8. Maintain a Lifestyle company
For some forward-thinking business owners this is a favorable business exit strategy. Pay yourself a huge monthly salary, reward yourself with a massive bonus irrespective of actual company performance. You can even issue a special class shares that solely owned by you and enjoy the dividends from them. In a lifestyle company, you keep things simple. Rather than reinvesting money in the business, you take out a comfortable chunk and live on the income of the business. This provides the business owner a relaxed 30-hour work week and a steady income from the business.
The drawback of a lifestyle company is simple "money in the wallet is no longer money in the company". If you own a business that must reinvest to grow, taking out too much capital will hurt your company down the road. Besides, if your business has other investors, taking too much cash will upset them. If you decide business for the lifestyle is the way to go, lower your dependency on other investors and organize the company such a way that allow you to draw out money as needed.
A business owner can gift equity or stock in the business as he or she sees fit. Usual recipients of the business owner’s reward are charities, organizations or family members. This gift can be a partial gift (retaining interest for a period of years or a lifetime interest) or a comprehensive gift (transferring all shares currently). In some cases this gift has obligations back to the business owner, which help the tax planning process.
10. Capital transfer
Many business owners don’t want a sudden retirement, they want to gradually move into retirement. A capital transfer exit strategy enables the business owner moving money out of the business without actually selling the company to an outside third party. The owner can start the complex process of recapitalization into voting and nonvoting stock or simply bonus out retained earnings as a dividend.
11. Liquidating the business
This option is appropriate when there is no alternative exit strategy available and immediate exit is desired. In this process, no negotiation is involved and no need to worry about the handover of control to new owners. Liquidation results in the most significant tax penalties and provides minimal proceeds to the company owner. Liquidation has a sole destroying effect on customers and employees and basically destroys everything the business owner has built, including relationships, reputation and client lists. Though, this exit route offers the owner cash and a speedy end of of the whole process.
12. Close the business
If the business doesn’t have any assets of real value and doesn’t have obligations such as leases, debts and the owner ultimately finds difficult to sell the business, he or she can simply close the business and walk away. However, if any corporate obligations exist, the responsibilities can be transferred to the business owner personally.
The 4-step exit process
ExitAdviser recommends you follow a four-step process to determine which option is best suited for you. This process will take into account the condition of your business and realities of the marketplace and ensure that exit plan is consistent with your personal goals.
Step-one: Fix your personal goal
Basically, you need to pinpoint two personal objectives: how much capital do I need from the exit plan to ensure my family’s long-term financial security? And other objective is, do I want any family member to run the business or a trusted employee should own the business?
Step-two: Set realistic goals that you can achieve
Set a realistic goal. For example, you may want to receive all cash when exiting the business, but today’s economic condition is such that many lenders require the current business owner to have "some stake in the company” even after the sale of the business.
Step-Three: Understand the market value and saleability
When consistent objectives are clear in your mind, you need to understand the market value and saleability issues. For instance, if you feel the value of your company is insufficient to support your family after you exit, you have to do further financial planning and put in extra effort to enhance the value of your business.
Step-Four: Tax and legal issues
Following this four-step process, you will be able to determine which strategy is best one to leave your company and hand over the keys.