Exit Plans: Having One Is Important
By: Dr. Bart A. Basi & Marcus S. Renwick
Starting and running a business can be challenging. Most business owners are intent on getting the day-to-day and year-to-year tasks done. For them making money in business means ultimately showing positive cash flow and a bottom-line profit. With this mindset, entrepreneurs often figure they will create and carry out their exit plans at some indefinite time in the future.
It always pays to be proactive in business, especially now. Do you remember the time you saw an item on sale for a large amount off and you did not buy it only to realize a month later you should have stocked up? Alternatively, have you ever owned an item that was more valuable to a buyer a month ago than today? Most of us can relate to these situations. If only the buyer or seller could have anticipated the situation, they would be better off economically today. It is a fact none of us can predict the future, but having a plan in place that anticipates future events and scenarios can help us gain economic advantages that will predictably come up in the future. This rule holds true for the sale of businesses.
If the business owner has an exit plan in place, opportunities might not be overlooked as easily as they could without a plan. The exit plan is intended as a device to get the owner to think about the future and serve as a guide once arriving at the point of exiting. This is why having a written exit plan is always important to have.
There are different types of exits to choose from. Most entrepreneurs who start businesses set their goal as going public with an initial public offering. While this is a respectable and admirable goal, for most it is not likely to happen. Most exits from the business at the small business level involve the acquisition or sale of the business. It is important to make a reasonable goal when creating an exit plan. This does not mean an IPO is unreasonable for everyone, but the business owner should think about possible alternatives to their primary goal or their intended exit. Below is a discussion of the different types of business exits or selling arrangements that can be made:
Initial Public Offering (IPO)– This exit involves selling stock to investors on a stock exchange. In doing this strategy there is a possibility of a high rate of return on your investment. The downside is that all the records of the company become public records. It is also very expensive and time-consuming to start and issue an IPO.
Sale of a Business – A business is sold to an individual, group of individuals or an entity. By doing this, the business owner receives cash or an equivalent for the business. However, it can be difficult to find a ready, willing, and able buyer to purchase the business. Merger – In this type of exit, the business joins with an existing company. As with a sale of a business, you get cash, stock, or a cash equivalent, but you join in with new partners and may suffer a partial or complete loss of control of your business.
Acquisition – Similar to the “Sale of a Business” exit, but usually involves an outright sale to another company. You receive cash right away, but you must find a ready, willing, and able buyer.
It is also important to note that businesses in some industries can exit easier than others. A Sale of a business may work better in noncapital intensive industries such as service sector businesses with relatively low values. If the business value is higher, as with capital-intensive industries such as manufacturing, retail, etc, it may be better to find a business-type buyer.
Most individuals cannot readily come up with a few million dollars to buy a manufacturing plant. However, many individuals can come up with $50,000 to $500,000 to buy a service sector business. IPOs are probably best suited for large, relatively known companies. Investors are reluctant to invest in smaller businesses without an ongoing reputation. Mergers can work well for any kind of business. Since cash does not have to exchange hands mergers can readily be accomplished by any other willing business.
Since we can’t predict the future, the business owner needs to adopt a “what if” mentality when thinking of exit plans. It is very simple logic. To follow it ask “What if” or “What should I do if ” and then name or state a scenario. Examples: What should I do if my business rapidly expands for five years? What if the economy enters a depression? While the form or wording of the plan is not important, this kind of thinking allows the business owner to cover a wide range of contingencies.
Although it may be useful to list many contingencies, you cannot plan for every contingency that arises. It is more important to select the more important scenarios from the many scenarios thought of. From there create a plan describing the actions and policies to be followed in the event the contingency comes to pass.
The following are the two most important contingencies and should be covered. They are: 1) When should I sell my business? and 2) What should I do if I must sell in an emergency? Examples of an emergency include illness, death, bankruptcy, etc. These two contingencies fall at opposite ends of the logic spectrum. One contingency is a best-case scenario. The other is potentially a worst-case scenario. Every other plan is in between these two. Without best and worst-case scenarios being covered, the plan is probably incomplete.
Every exit plan should take into account different factors such as the industry, competition, the owner’s resources and goals, and any other relevant intangibles. The best plans take into account all of the affected persons’ goals.
Now that the scenarios in which to sell a business have been outlined, some homework and basic research must be done. This is important because it is important to thoroughly know your business and what is in place before you make a plan that may be redundant, ineffective, or void in light of existing agreements. You may want to call in an advisor for legal, accounting, and tax issues that arise so they can interpret them for you.
It is probably best to think of potential scenarios and then eliminate them at this stage because the previous stage defines what is important to YOU, not what is important to EVERYONE ELSE. Doing the process this way will not lead you astray into what others believe is important.
The homework consists of reviewing any existing agreements you have with partners, shareholders, and others who are important in the organization. The agreement may consist of articles of incorporation, by-laws, and buy/sell agreements. The exit plan must conform to the existing agreements or it could defeat the plan. If you don’t have any existing agreements between shareholders and partners, now may be the best time to create them in conformity with the plan you want to follow. Remember, a buy/sell agreement is the most important legal document a business can have that covers exit strategies.
WRITING THE PLANS
After doing the homework, the rest of the plan can be written. The plans do not necessarily have to be complicated or even well written to be effective when the scenarios arise. The most effective plans are the plans that are most thoroughly thought out, so it pays to think at this stage.
The Goal - It is important to define a goal. The main goal in any exit plan is to achieve the best results. These results may include reviewing the biggest monetary gain, the smoothest transition into the next generation, paying the least taxes, or creating a retirement plan. The goals in the plan are not as important as the plan itself.
The Players - Next it is important to choose the players to be involved in the exit plan. Decide what partners or key people will handle what or what you would like them to do. When the time comes, the people named may not be willing to do the task, so be wary of this situation.
To prevent an unexpected withdrawal or nonperformance by a team member, these people should be people you have known for a while and are trustworthy. While you don’t have to be an expert on personal character, it is generally best to choose people with an interest in conformity to yours, people without incidents of mistrust or fraud in their past, and generally, people that anyone would think are trustworthy.
It is also important to decide who will represent you in your exit. An experienced professional accountant or attorney with a tax background complemented with an understanding of legal implications is probably your best bet here.
Valuation of the company is also important. Even though the valuation won’t take place today, it is important to identify a company or professional that has expertise in this specialized area. A poor valuation can lead to selling the business for way too little. An entire lifetime of hard work and sacrifice should not be lost through a shoddy valuation. It would not be fair to you or those around you. Valuation of a company should take place every year because the results of the operation are important.
Potential due diligence issues then need to be addressed. Due diligence is the process of ensuring the accuracy and completeness of assertions. It is best to address the issues now rather than wait until the sale. An issue in due diligence can result in a deal-breaker.
Being proactive in business pays. It especially pays when you are dealing with the sale of a business. Dealing with the issues that come up now can eliminate lost opportunity, headaches, and problems that may not be able to be solved when the sale occurs. Therefore it is important to have an exit plan at all stages of business. If you like, please contact the professionals at The Center for further assistance in your business and tax needs.