Do you have an exit strategy?
You’ll find plenty of advice on building a successful business, but people don’t talk so much about how to leave it behind.
And yet there are many good reasons for wanting to exit a business. Maybe you’ve found a better opportunity elsewhere, and want to start a new venture. Maybe you want to retire or scale back. Maybe your business has just run its course, and you don’t have the passion for it any more. Maybe you need to raise cash quickly, and selling your business is the only way.
Even if you don’t plan to leave any time soon, it’s worth thinking through your exit options and having a strategy in place. Each one has its own particular advantages and disadvantages.
In this tutorial, you’ll learn about the various strategies business owners can use to sell or exit from their companies, will see the pros and cons of each approach, and will learn some important things to keep in mind if you decide to go ahead and exit your business.
1. Pass It On
The natural transition for many family businesses is simply to pass ownership on to the next generation. In reality, however, it’s often not quite so simple. Here are some things to be aware of.
When you pass your business on to a family member, the main advantage is continuity. No outsiders need to be involved: you can pass on your business to someone you trust, and see it stay in the family for another generation. It’s also a great way to provide for your children’s future, if running the family business is something that interests them.
Also it can be relatively simple to complete the transition, if everyone is in agreement. You don’t have to go in search of external buyers, negotiate a sale, and endure a complex due diligence process. It can be a smooth transition with minimal impact on the running of the business.
Unfortunately, not all transitions to the next generation go so smoothly. Sometimes your son or daughter may have different ideas about how to run the business, or there can be conflict between siblings over who has control.
In extreme cases, families can be torn apart by disputes over the direction of the business. The father-and-son owners of a luxury hotel chain in the UK ended up in court in 2013, with the father suing his son for about £50 million, claiming he had excluded him from his own business.
Also consider the tax implications. If you transfer ownership of the company either for no payment or for less than its market value, the tax authorities may view it as a gift and charge gift tax. The rules are complicated, so be sure to check with your accountant or financial advisor and ensure that you make the transfer in a way that doesn’t land your successor with a large tax bill.
Tips for Success
Know your family, and make a decision based on what’s right for the business. Consider taking on external advisors to get a more objective view, as well as creating a formal succession plan to ensure that expectations are set clearly on all sides.
Also ensure that you’ve passed on all the necessary skills and training to your successor, and consider creating a “roundtable” or family board to ensure that major decisions are made fairly, with involvement of all family members, and that any potential conflict is quickly defused.
2. Management or Employee Buyout
If passing your business on to a family member is not an option, consider another “friendly buyer” like your existing managers or a group of employees. They can pool their funds and buy the business from you.
A management or employee buyout is also great for continuity. These are people who know exactly how your business is run, and have the skills to continue running it successfully. They may pursue a slightly different strategy, but it’s still likely to be a smooth transition. It’s also satisfying: business owners often worry about what will happen to their long-term employees when they leave, and what better way to know they’re well taken care of than for them to be the new owners?
For your employees to buy you out, they have to get the money together first. This can be a problem, especially with larger, high-value businesses. In some cases, the group of managers or employees will need to take out a large loan to fund the purchase, which can be difficult to arrange.
One solution is for them to pay your gradually over time out of the company’s profits, but this is an obvious disadvantage for you as a seller, both because there’s a delay in receiving the money, and because there’s a risk that the company will struggle and they won’t be able to pay you the full amount.
Tips for Success
As with option one, the main danger here is in letting personal relationships cloud your judgment. Negotiating a price can be difficult with people you know well, and you may end up leaving money on the table. So try to keep things strictly business, and bring in outsiders to value the business and draw up a fair agreement. When the deal is completed, resist the urge to stay involved, unless you’re asked to of course. Generally it’s better to step away and let the new owners run things in their own way.
3. Trade Sale
This option involves selling to another company—perhaps one of your competitors, or a larger firm looking to acquire a subsidiary in your industry.
A trade sale can be an efficient way of getting the best price for your business. If another company sees your business as the perfect strategic fit, it may be willing to pay well over the odds. To take an extreme example, Facebook paid $19 billion for messaging company WhatsApp when it was a relatively new company with just 55 employees. It was very expensive, but Facebook was willing to pay that much for access to a younger, mobile customer base.
If you’re lucky, or just popular, a bidding war may develop between rival companies, sending the price of your company much higher than it would be in the other options.
You’re not passing your business on to family or employees any more. The buyer could be your arch competitor, or a large company that doesn’t care about your values or goals. Once the deal is done, you may see your business run in a completely different way, merged into a larger firm, or even broken up. The employees you worked with for so long could be laid off.
This doesn’t always happen, of course—there are plenty of amicable trade sales in which the firm continues with little disruption. But the point is that you don’t have control over the destiny of your company, and that can be painful for many business owners.
Also, on a personal level, you sometimes have to sign “non-compete agreements,” pledging not to set up a rival business in the same area for a certain time period or to hire away your old employees, and in some cases they can be quite restrictive.
Tips for Success
To make your business attractive to other companies, you may need to make some tough changes. For example, a company that is overly reliant on your own skills and expertise won’t fetch a good sale price, especially if you’re planning to step aside after the deal is done. Buyers want to see a company that can function independently.
Also make sure your internal processes will stand up to scrutiny from an outsider. A potential buyer will do extensive “due diligence” work to investigate your business and make sure it’s healthy, and the informal practices of some entrepreneurs can derail a deal, or at least reduce the price. Common red flags include “handshake” deals with little or no formal documentation, and employing friends or family members as favors.
After all the work you’ve put into building your business, closing it and selling off all the assets is probably not the exit you had in mind. Generally it’s a last resort, when the business is failing and the other exit options are not viable. Here’s a look at when it’s a good idea, and what the disadvantages are.
Liquidation is a simple, clean solution. There’s no transition plan to worry about, no buyers to negotiate with. You just list all your assets and sell them off, either to customers, competitors and suppliers, or in an auction. Anything that’s left from the proceeds of the sale, after paying off all your creditors and any other shareholders in the business, belongs to you. It can be a quick way to exit a business and extract at least some of the value.
With a liquidation, you’re almost certainly not getting anywhere near the full value of your company. For one thing, you’re usually only selling the physical assets. Often a large part of a business’s value is in things like its reputation, its employees, its knowhow and its relationships with customers, and those things are hard to liquidate.
Also, even the physical assets are typically not sold at full value. We’ve all seen those “Closing Down” sales at local stores, where the merchandise is deeply discounted so that it sells quickly. Even if you don’t run a retail store, liquidating your company is the equivalent of running a “Closing Down” sale. Buyers know that you need to sell quickly, and you’ll struggle to get good prices.
Tips for Success
Because liquidation is likely to generate less value than other exit options, it’s important to present your liquidation plan to creditors and shareholders, and get their approval before you act. Then it’s about conducting a detailed inventory of all your assets, and deciding on the best way to sell them. Options include selling directly to a competitor or supplier, selling all your goods in bulk to a dealer, holding an auction, or holding a retail sale to customers. For more detail on how to liquidate successfully, read the useful step-by-step guide prepared by the Small Business Administration.
5. Other Options
These are the main options for a total exit from your business, but you do have other alternatives, particularly if you’re looking for a partial exit. Perhaps you don’t want to walk away from your business, but just want to take some money off the table and take more of a back seat in the running of the business.
In that case, some of the options we looked at in our recent Funding a Business series could be worth looking into. Some business owners, for example, invite private equity firms to invest in their business as a partial exit strategy. They sell a large portion of company stock to the PE firm, and hand over some of the managerial control. The idea is that the private equity investors make the firm more valuable during their five-to seven-year involvement, and then arrange a sale or IPO, at which point the owners can either fully exit themselves, or stay on as minority stakeholders.
IPOs, as well, can be used as partial or even full exit strategies. The original owners often stay in place after an IPO, but some take the opportunity to sell the bulk of their stock and pass on the management reins to someone else.
As you’ve seen, the route you take depends on what you want to achieve, and what’s important to you.
Passing a business on to a family member is a good idea if you have a willing and able successor, but can sometimes cause conflict, and needs to be carefully managed. Management or employee buyouts keep some continuity in the business and reward loyal employees, but can be difficult to arrange if the company has a high valuation.
Trade sales often offer the best price for a company, but mean loss of control. And liquidation is a “last resort” option for exiting a business cleanly, but usually without realizing its true value.
The key, no matter which option you choose, is to plan early. If your life circumstances changed suddenly, what would you do? Make sure you have a strategy mapped out, so that you’re prepared to exit your business when the time comes.
That includes making provision for life after business ownership. A 2014 survey found that nearly 70% of entrepreneurs and self-employed people are not saving regularly for retirement. If you sell your business for millions, that won’t be a problem. But if the sale amount is smaller, or if you want to pass the business on to a family member for a token amount, then you’ll need to make other provision for yourself.
These and many other personal choices will affect the type of exit you choose, so it’s best to start planning and consulting your financial advisor as soon as possible. If you start early and do it right, exiting a business won’t be a headache, but a smooth transition to the next phase of your life.
Editorial Note: This content was originally published in 2014. We're sharing it again because our editors have determined that this information is still accurate and relevant.