How To Pick An Exit Strategy For Your Small Business

An exit strategy is something that every investor in a small business looks for. But even if you are running a one person sole proprietorship, you need an exit strategy. For you, as for any investor in a business, the questions are the same when it’s time to move on:

  • How are you going to get your money out of the business?
  • And how much money are you going to get?

Having an exit strategy worked out in advance helps ensure that you like the answers to those questions and gives you some control over your small business’s future.

Here are seven exit strategies for small businesses to choose from:

1) Liquidation

This is the close up shop and sell all the assets exit strategy. For small businesses, especially those that are dependent on the performance of a single individual, liquidation is sometimes the only option as there’s really nothing else to sell. If you’re in this position, you may want to spend some time retooling your business so that it could be operated by someone else – making it a business someone might want to buy.

Advantages

  • Simplicity
  • The business can be wound up very quickly (depending on the sale of assets).

Disadvantages

  • Liquidation has the lowest return on investment to the owner(s). The only money from a liquidation sale is from the disposal of assets, such as land, equipment, or inventory – any goodwill value from client lists or other business relationships (which may be substantial) is lost.
  • Second hand business asset values for items such as machinery and equipment can be very low, even in a non-depressed market.
  • Creditors (if any) have first claim on funds from asset sales.

2) Liquidation over time

In this exit strategy scenario, the owner(s) extracts most or all of the profits out of the business over time (before eventually selling or closing the business), rather than reinvesting them in the company for expansion.

This is typically done by taking out large salary draws or dividends over a number of years before eventually winding up the business, and is suitable for owner(s) who wish to maximize their current lifestyle rather than aggressively expand their business.

Advantages

  • Lifestyle – maximizing cash withdrawal on an ongoing basis for personal use (rather than waiting for an eventual windfall from selling the company)

Disadvantages

  • Extracting the profits reduces the growth potential and eventual sale value of the business.
  • Other shareholders (if any) are likely to object unless they are similarly compensated.
  • Salary is taxed as personal income, whereas profits remaining in the company increase the value of the business and will taxed as capital gains when the business is sold.

3) Keep your business in the family

The dream of many small business owners, keeping your business in the family ensures that your legacy lives on and provides a living for your heirs.

Advantages

  • Can make for a smooth transition by grooming a family successor
  • May allow for you to keep a hand in the business in an advisory (or other) capacity

Disadvantages

  • Developing a family succession plan can be enormously difficult and lead to infighting among family members over ownership and/or participation in the business.
  • Family members may not have the skills (or interest) to take over the business.
  • Clients may not approve of new management or changes in company direction.

For more on this exit strategy and tips for successfully passing your business on to family, see Family Business Succession Planning.

4) Sell your business to managers and/or employees

Current employees and/or managers may be interested in buying your business.

Advantages

  • The business can thrive as employees will get an established business that they are familiar with and are enthusiastic about.
  • Arranging a long-term buyout by employees can increase loyalty and greatly motivate staff to work hard to make the business succeed.
  • May allow for you to keep a share of the business and stay on in an advisory (or other) capacity.

Disadvantages

  • Employees may not be suitably qualified to take over the business.
  • Clients may not approve of new management or changes in company direction.

One way of setting up this exit strategy is through an Employee Share Ownership Plan (ESOP), a stock equity plan for employees that lets them acquire ownership in a company. However, an employee buyout doesn’t have to involve a stock equity plan. It might be as simple as having one of your current employees take over the business with a straight purchase.

5) Sell the business in the open market

This is the most popular exit strategy option for small businesses. At a certain point in time, often when he or she is ready to retire, the small business owner puts the business up for sale for a certain price – and hopefully walks away with the amount of money she wanted to get for it.

Advantages

  • A profitable business should be attractive to buyers and sell quickly.
  • Assets and goodwill can be incorporated when valuing the business for sale, maximizing the return to the owner(s).

Disadvantages

  • A marginally profitable business can be very difficult to sell – according to BizBuySell, only 20% of all businesses listed for sale actually sell. Finding a buyer on the open market can be a long process.
  • Businesses can be difficult to value and the selling price may be much lower than expected.

If this is your exit strategy, you should spend some time grooming your business for sale, making it as attractive as possible to potential buyers. See 5 Tips for Selling a Business and Top 7 Ways to Maximize Your Exit Strategy for Maximum Profit for more details.

6) Sell to another business

Positioning your small business to be a desirable acquisition can be very profitable. Businesses buy other businesses for all kinds of reasons, such as using a new acquisition as a quick path to expansion, realizing synergies from complementary business activities, or simply buying out (and getting rid of) the competition.

Advantages

  • For the above reasons, a competing business may be highly motivated to purchase your business, making for a quick sale and maximum profit.

Disadvantages

  • If the purchaser’s only motivation is to reduce the competition, they may fold your business after purchase. Any existing employees may lose their jobs.
  • A competitor may only pretend to be interested in purchasing your business in order to get access to your customer list and financial information.

The trick to success with this exit strategy is to target your potential acquirer(s) in advance and position your company accordingly. And of course, convincing your acquirer that your small business is worth what you want for it.

7) The IPO (Initial Public Offering)

While not suitable for all small businesses, the IPO can be a viable exit strategy.

Advantages

  • Taking your company public can be extremely profitable.

Disadvantages

  • Becoming a public company is a long, costly process.
  • Depending on how the IPO is structured, you may or may not be able to withdraw any of your capital at the time as new shareholders may want to see all the money raised by the IPO be used to expand the business.
  • Public companies have much higher compliance and reporting standards. As an owner you may be personally liable or subject to prosecution for any prior accounting “irregularities” or failures in disclosure.

The Best Exit Strategy

The best exit strategy is the one that best fits your small business and your personal goals. Decide first what you want to walk away with. If it’s just money, an exit strategy such as selling on the open market or to another business may be the best pick. If your legacy and seeing the small business you built continue are important to you, then family succession or selling to employees might be best for you.

Whichever exit strategy you choose, you need to start working on it. Planning in advance gives you the time to do it right – and maximize your returns.

Pick the Exit Strategy That’s the Best Fit

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The Four D’s of a Business Exit Strategy

Those who have created a successful business know it does not happen without planning, hard work, and a little luck. Yet most have no exit plan for leaving their business. The truth is that most business relationships do not have happy endings. To have a successful business, you must plan for all four D’s of a business exit strategy.

The idea that your business will provide you with income after you are no longer there may not be a reality. You have to depend on yourself. Take the time to look at the four D’s of a business exit strategy: death, disability, divorce, and departing. To have a successful business, you must plan for all four D’s.

The Four D’s of a Business Exit

Death: The issue of the death of a small business owner should be considered during the start-up of a business. Unfortunately, during the creation of many buy/sell agreements the issue of death is only addressed at the urging of a life insurance agent. At the meeting, you arbitrarily decide how much insurance you can afford and how much your company is worth when in fact you do not know.

Disability: Death is not as likely to end the business relationship as a disability. Small business survival will often take prescient overpaying a disabled partner. If the person is important to the business, the financial strain impacts the business and the family who depends on the income.

Divorce: You can imagine the torn feelings if a disability occurs, but what if the partners cannot get along? How do we split a partnership without financially ruining each other? It may be complicated by many personalities, some may not even be a part of the dispute, yet may be affected financially.

Departure: You may all be happy working together, but your partner or you may decide to leave for another opportunity or simply to take life easier. Who is going to do the work? What is owed the leaving partner? Where is the money coming from? All important considerations for your business exit strategy.

A Fair Buy/Sell Agreement

For the small business owner, each one of the four D’s has special demands: family, income, taxes, and transfer of control of assets. An agreement, commonly called buy/sell agreements, can be used to handle the four D’s. The concern of the family or income can conflict with the business. The business exists as a separate entity. Reduce conflict by developing mutual fair agreements and the desired level of income.

Creating a Business Exit Strategy

Once you understand the four D’s, include the following actions in the creation of your business exit strategy:

  • consider incorporating your small business to recognize yourself and your business as separate entities legally
  • find a method of determining the value of the corporation that can be done at least annually and will qualify under IRS standards
  • develop an employee benefit plan that will assist with the departure of each partner in case of death, disability, or retirement
  • plan for who retains company ownership and who gets paid off

The great American dream is to: build a business of your own; bring it to life; make it successful. How you plan your small business exit strategy will determine your financial success. Just as building a successful business takes planning, hard work, and a little luck so does leaving it.

Writing a Business Plan: Creating a Business Exit Plan

All good business planning documents have a clear business exit plan that outlines your most likely exit strategy from day one.

It may seem odd to develop a business exit plan this soon, to anticipate the day you’ll leave your business, but potential investors will want to know your long-term plans. Your exit plans need to be clear in your own mind because they will dictate how you operate the company.

For example, if you plan to get listed on the stock market, you’ll want to follow certain accounting regulations from day one that’d otherwise be non-essential and potentially cost prohibitive if your ambitions are to quickly sell the company to a more established competitor in your industry. If you plan to pass the business to your children, you’ll need to start training them at a certain point and get them invested in the company from an early age.

Here’s a look at some of the available strategies for entrepreneurs who want to build a business exit plan into their early planning process:

Exit Strategies for Long-Term Involvement.

  • Let it run dry: This can work especially well in small businesses like sole proprietorships. In the years before you plan to exit, increase your personal salary and pay yourself bonuses. Make sure you are on track to settle any remaining debt, and then you can simply close the doors and liquidate any remaining assets. With the larger income, naturally, comes a larger tax liability, but this business exit plan is one of the easiest to execute.
  • Sell your shares: This works particularly well in partnerships such as law and medical practices. When you are ready to retire, you can sell your equity to the existing partners, or to a new employee who is eligible for partnership. You leave the firm cleanly, plus you gain the earnings from the sale.
  • Liquidate: Sell everything at market value and use the revenue to pay off any remaining debt. This is a simple approach, but also likely to reap the least revenue as a business exit plan. Since you are simply matching your assets with buyers, you probably will be eager to sell and therefore at a disadvantage when negotiating.

Exit Strategies for Short-Term Involvement.

  • Go public: The dot-com boom and bust reminded everyone of the potential hazards of the stock market. While you may be sitting on the next Google, IPOs take much time to prepare and can cost anywhere from several hundred thousand to several million dollars, depending on the exchange and the size of the offering. However, the costs can often be covered by intermediate funding rounds. Keep in mind, that the likelihood of your company ever going public is very low, as you’ll likely need to reach into the tens of millions of dollars in annual revenue before you’re an attractive IPO candidate.
  • Merge: Sometimes, two businesses can create more value as one company. If you believe such an opportunity exists for your firm as a business exit plan, then a merger may be your ticket. If you’re looking to leave entirely, then the merger would likely call for the head of the other involved company to stay on and take over your company’s activities. If you don’t want to relinquish all involvement, consider staying on in an advisory role.
  • Be acquired: Other companies might want to acquire your business and keep its value for themselves. Make sure the offered sale price meshes with your business valuation. You may even seek to cultivate potential acquirers by courting companies you think would benefit from such a deal. If you choose your acquirer wisely, the value of your business can far exceed what you might otherwise earn in a sale.
  • Sell: Selling outright can also allow for an easy exit. If you wish, you can take the money from the sale and sever yourself from the company. You may also negotiate for equity in the buying company, allowing you to earn dividends afterwards — it clearly is in your interest to ensure your firm is a good fit for the buyer and therefore more likely to prosper.

Create a profitable business exit plan from the start.