Exit Strategy: How to Create One for Your Small Business
Owning your own small business is a dream that few are fortunate enough to realize, but even those new to the joys of entrepreneurial self-determination need to spend time thinking about how you’re going to eventually leave the business. No matter how far off it may seem, the best way to ensure that your time in your business meets your personal goals and expectations is to prepare an exit strategy now.
Crafting an exit strategy long before you leave may feel like starting a meal with dessert, but there are plenty of benefits to doing so. It helps you understand all your options and what the potential outcomes of each may be. Let’s take a closer look.
Why an Exit Strategy is Necessary for a Small Business
Though you may think of an exit strategy as only suitable for big corporations or partnerships, every business should have one so that ownership can be transferred without being hampered by negotiations or stress. As with so many things in life, the more planning you do ahead of time, the less aggravation you are likely to encounter when the time comes. If you’re just starting to think about what your exit strategy should encompass, make sure that you think about the following:
What are the expectations of your business in the long term, what your financial needs are now, and what are they likely to be in the future
How long do you want to be involved with the business
Who else has been involved in the business, what will their needs be, and how will you meet those needs
Those are the key issues that an exit strategy takes into consideration, and keeping them in mind will help you to ensure that you’ve addressed everything that you need to in a strategic and organized way. Even if the particulars involving these individual elements change over time, having a rudimentary exit strategy already in place will make modifications easier.
The Most Common Exit Strategies Used by Small Businesses
There are several different ways to leave a small business, but the five shown below represent the most commonly used:
This is the straightforward process of selling a business’ assets. Liquidation can be done in two different ways.
Close and sell assets quickly – Business owners who do this often find themselves unable to leverage goodwill, client lists, and other non-tangible assets. They only monetize assets that they sell and end up losing value. Though this has the advantage of being a simple and quick process, it often leaves you with less than you could realize if you take your time and only allows you to take advantage of tangible assets like equipment or inventory. It also leaves you in the position of having to pay off creditors immediately with the proceeds.
Liquidating over an extended period – This option represents a move from reinvesting funds into the business to paying yourself with the business’ revenues. Small business owners who choose this “lifestyle business” option run their business until they are no longer earning money and are able to maintain their lifestyle and then close. Though many prefer this option, it has a deleterious impact on the business's growth potential and your ability to consider selling it for a profit. It may work well for sole proprietors, but it is not a good option for businesses with investors who want to earn a profit or get paid. Choosing this option also requires consultation with a tax professional.
Small business owners considering liquidation need to consult with experts who can advise them on the right approach to asset sales, addressing liabilities, how to handle existing employees, and more to ensure that all their commitments and obligations have been legally and responsibly addressed.
Selling the business to someone familiar such as a family member, friend, employee, or customer
In most cases, this involves a process formalized by a seller financing agreement that outlines a gradual purchase that provides income to the seller and avoids a large initial investment for the buyer. Often, these agreements involve either formal or informal mentoring as the business transfers hands to allow a smooth transition. Though it may be tempting to arrange a sale to a friend informally, it is important that everything is done with the help of an attorney and accountant to ensure that valuation and other issues such as estate planning and family succession can be addressed if appropriate.
There are many advantages and disadvantages to this type of arrangement. By having an exit strategy in place that makes current employees into eventual owners, you create more goodwill and loyalty and inspire greater productivity and creativity. It also allows you to continue being involved and ensures a smoother transition of business operations.
However, this type of plan can also create jealousy and competition between family members or employees and may lead to your undervaluing your own business as you attempt to help those you care about.
Selling the business on the open market
Many entrepreneurs are looking for established, successful small businesses to purchase, as it avoids much of the hard work and risk initially involved. Entrepreneurs will find it easier to secure financing for a business that has a known revenue stream, goodwill, cash flow, and systems in place. To make yourself as attractive as possible to this type of buyer long before putting your business on the market, make sure that all of your records and financial papers are in order, and check out helpful information like this from the Small Business Administration to make sure that you are leveraging all of the features that you have already worked so hard to establish.
Selling your business on the open market is a great exit strategy for those whose businesses have a solid financial foundation and well-established clientele and reputation. However, the process can be drawn out and disappointing, especially if the offers you receive are lower than your valuation expectation.
Selling to an industry insider
Competitor businesses may believe that your small business is a good acquisition, whether to add to their portfolio or to eliminate competition. Similarly, employees in a related industry may be interested in ownership of a company that is already well established so that they can leverage their experience without having to start from scratch. This can be a particularly good option if you wish to remain in the business but in a consulting role with fewer responsibilities. However, many previous owners are disappointed with their new role, the changes in the business culture or approach, or the disposition of long-tenured employees. This type of scenario requires extensive involvement with an attorney to ensure that all aspects of the acquisition agreement are clear and that the valuation is appropriate.
Initial Public Offering (IPO)
This approach involves selling shares of the company to the public to raise capital. Though the process takes time and is expensive, it goes a long way to earn a company's public recognition and brand awareness and can be very profitable. Going public also involves a significant amount of documentation and regulatory compliance surrounding reporting and being open to the opinions and desires of shareholders in how the company is operated.
Before you make any large decisions or moves regarding your business, be sure to consult with our office.