You’ve spent years building your business. It’s been a labor of love from the beginning and has become your identity. You’re now at the point where you start to think about what comes next. Maybe you want to cash in and retire or perhaps you’re bored and want to focus on a new endeavor. The only problem is you realize that exit planning is a subject that has completely eluded you. You’ve been so focused on creating and maintaining your enterprise that you’ve failed to plan for how you’ll eventually exit the stage gracefully.
You’re not alone. Exit planning is often overlooked in the life-cycle of a business. The enormous amount of detail to which a business owner must attend often overshadows long-term planning. The good news is that it’s never too late to start.
Types of Exits
Exit planning doesn’t mean that you have to sell your business. There are a number of factors however, that make your company both more valuable and more attractive to potential buyers. Focusing on these will dramatically improve your business even if selling isn’t part of your plan. There are many exit strategies that will allow you to change course on your own terms. Some of the most common strategies include:
This is where you sell your business, hand over the keys and walk away. Surprisingly (or not so much), this is not very common. Most businesses are not structured in a way that allows a new buyer to take over operations without the involvement of the prior owner.
Sale With an Earn-Out
More often than not, selling a business requires a willingness to stay with the company for a few years during the transition. Buyers will often offer this type of purchase with an “earn-out”, meaning that you will receive part of the purchase price up front in cash, stock or some combination thereof. The remainder is paid out over time based on hitting certain targets during the transition period. This is less desirable than some other exit types as it transfers much of the risk to you.
Sale With a Consulting Arrangement
Sometimes, buyers will offer to purchase your business for a set price but will require you to stay on as a consultant for a set period of time. This is better than an earn-out, since the price you’ll receive is guaranteed but it stills prevent you from sailing off into the Caribbean.
Partial or Equity Sale
In an equity sale, you sell part of your business to a partner; either an individual, investment group or private equity firm. You can sell a minority stake in the company and continue to run it, sell a majority stake and become a passive investor, or anywhere in between. There are many possibilities and the benefits to you depend on your specific circumstances.
Hand Off the Daily Management to Others
This type of exit typically involves bringing in a Chief Operating Officer to manage the daily activities of the business. You can stay on as CEO to make the big decisions, you can bring in a CEO to manage the entire business for you, or you can transfer the business to children or other family members. The key is removing yourself from some or all of the daily responsibilities of running the business.
Sell your business to people on your team that are interested and capable of taking over. This can be done through a direct sale or through a more complicated structure such as an Employee Stock Ownership Plan (ESOP).
Selling off your company for the value of its assets is generally not the preferred exit strategy. With that said, there may be circumstances where it makes sense. Let’s say that you own a business that manufactures buggy whips. The industry has been declining since Henry Ford starting mass-producing the Model T. It’s not a particularly innovative product and certainly doesn’t have much growth potential. As such, there are probably very few potential buyers out there.
Now let’s say that the machinery required to make your buggy whip is very expensive and can be re-purposed to make many other modern products. And you own it free and clear. It may make sense to sell off the assets and just close the business.
As a business owner, you have many options to consider as part of your exit planning process. You need to be clear on exactly why you want to exit. You have to take that into consideration when deciding which exit strategy is the best fit. You’ll also need to consider how your employees will react and how your chosen exit will affect their lives. Most importantly, you need to know what it is you want to do once you’ve thrown off the chains of business ownership. Addressing these points honestly is crucial to choosing the exit strategy that’s right for you.
Strategic vs Financial Buyers
If you plan to sell your business, exit planning requires identifying potential suitors. There are two types of buyers that you will work with. These are Strategic Buyers and Financial Buyers. Each have their own motivations for acquiring your company that you should understand before pursuing any one strategy.
Strategic buyers are interested in buying your business to add value to their existing operations. Their interest goes beyond simple financial considerations and is often driven by how your company fits into their long-term business plan. They may be a direct competitor, a supplier or even a customer. If not in the same industry, a strategic buyer will typically be in a closely related industry that can gain synergy or efficiency by acquiring your business (a manufacturer buying a steel supplier, for example).
This type of buyer can be beneficial because they will often have the expertise to take over your business without requiring you to stay on. They also may be willing to pay a premium above the industry standard multiple because of the strategic value in adding your business to their own. The downside of a strategic buyer is that your pool of potential acquirers is going to be much smaller.
Financial buyers, on the other hand, are typically investors. They are not limited to a specific industry and are generally not looking at your business as an addition to an existing enterprise. Financial buyers are concerned with your business and your business alone. This opens up your pool of potential buyers significantly. This also means that your business has to be structured in a way that it can operate on its own. A business that requires the buyer to have specific technical knowledge in order to operate it is not going to be a good fit for a financial buyer.
The best option is to structure your business in a way that it’s a viable option for both strategic and financial buyers. This will give you the largest possible pool of potential buyers. A large buyer pool will help you sell your business more easily for the highest potential price and/or best possible terms. In order to do that, you need to build your business with that in mind and create the conditions so that it can run on autopilot as much as possible.
What does your P&L look like? While it may be fairly obvious, one of the key factors that adds value to your business is your history of generating revenue and profit. Buyers are not purchasing your assets. They are purchasing a future stream of profits. You need to be able to document the ability of your business to produce profits now and into the future. The more confident a buyer is in this, the less they will need to discount their offer to account for risk. Professional record-keeping is an absolute must if you want to inspire confidence with a buyer.
Are you in a growth industry? Because buyers are purchasing a future income stream, they need to know what the future growth of your business looks like. A high growth potential in a growing industry is much more attractive than a declining potential in a mature industry. Even if you find yourself in the latter category, it’s never too late to innovate, even if that means shaking up your business model. Consider re-focusing your efforts on only the products with the highest potential for growth.
Dependence on Employees, Customers and Suppliers
Do you have dependency issues? Having a small number of employees, customers and/or suppliers that your business can’t function without puts you in a position of weakness. Develop the talent of your team so you can spread the responsibility around. Make it so you’re not reliant on one rock-star employee. Manage your sales so that no single customer accounts for more than 10-15% of your business. The same goes for your suppliers. Spread your purchases around to multiple vendors so trouble with one has as little impact as possible.
Does your business generate cash, or does it consume it? When you sell your business, the buyer will be writing two checks. One to you for the agreed upon purchase amount and another to fund the working capital needs of the business. Cash flow and the purchase price have a direct and inverse relationship. The more cash your buyer has to use to fund the business, the lower the purchase price they’ll offer. Improving your cash flow goes a long way to making your business more attractive to a buyer.
How much of your revenue comes from recurring business? A business that generates automatic recurring revenue is more attractive than a business that requires finding new customers for every sale. Subscription-based businesses are the pinnacle of recurring revenue and are very attractive to buyers. Your business may not sell a product that’s conducive to this but that doesn’t mean that you can’t find a way to produce automatic revenue streams. Think about what you can offer customers on a regular, ongoing basis. Perhaps you can offer service agreements or training classes for the products you already sell. Be creative.
What differentiates your business from your competition? No matter how innovative a product or service is, eventually it will become a commodity. Whatever it is that you sell, you need to have something that differentiates you from your competition. Maybe it’s a unique brand promise or perhaps it’s an innovative way to deliver a generic product. Again, be creative and find a way to make your company stand out in a crowd. Think Dollar Shave Club.
How many of your current customers would refer friends and family to your business? This one question has been used for decades to measure how well you take care of your customers. It is also a reliable predictor of how likely they are to continue to do business with your company in the future. Since a potential buyer is buying an income stream, this is very important information for them to have.
Can your business run without you there? This is one of the most challenging aspects of owning a small business. You’ve built your business from the ground up and have been directly involved with every step. The hardest thing you will do is to disconnect from what you’ve created but if you can’t, you don’t own a business. You own a job.
You can fix this too. Build simple, repeatable processes that you can train your staff to perform. Mentor them and help them to develop good judgment and decision making skills. Involve your people in your long term strategy and help them to think like entrepreneurs. Only then will you be able remove yourself from the daily business activities. It takes time but eventually your business will function effectively without you. This is what separates a business that will fetch top-dollar from one you can’t unload to save your life.
Exit planning is a critical process for every entrepreneur to engage in. There are myriad opportunities to increase the value and attractiveness of your business. Whether you want to sell or just want to know that you can, focusing on these opportunities benefits you either way. In fact, you may find that by implementing the structure that allows your business to operate effectively without you, you’ll find the freedom and income to pursue other endeavors without selling. Or with selling. It’s up to you.
Photo by Robson Hatsukami Morgan on Unsplash
Robson Hatsukami Morgan