Although there are many variations, there are really only a few realistic exit strategies for most business owners. Most strategies only make sense for certain classes of business, so for any given business, even fewer options are viable. Here we review these basic options, which types of businesses they work for, and outline the pros and cons of each.
The owner of a residential construction firm (with over 100 contractors) had a heart attack at least partly because he was so stressed by the daily hassles of running his business. He survived, but decided to simply give his business away to a friend because he couldn't handle the stress. Given the fact that his business was well established and generally profitable, by giving the business to his friend, the owner probably missed an opportunity to sell the company for several million dollars.
Lesson: A lack of planning is often the same as planning to fail.
Another business owner built his real estate consulting company to about $60 million annual revenues over 20 years. At the peak he had over 200 aggressive brokers and sales people generating revenue, and he paid himself most of the company's profits each year. Along the way he came close to going broke several times, because there simply wasn't enough cash to keep the business going. He also alienated large numbers of dedicated employees who had worked very hard to grow the company and were constantly frustrated by the apparent lack of planning. About 7 years before he sold the company he began preparing the company for a sale. He cleaned up the company (hired a management team, formed an advisory board, documented internal procedures, upgraded the company' computer systems, etc.). He also brought in a variety of consultants and reviewed every aspect of the company --- IT, accounting and finance, marketing and sales, etc. He ended up selling the company for over $100 million.
Lesson: Planning usually pays off.
A public company formed a third party fulfillment business in the late 1990s. The parent company planned to spin off the subsidiary through a sale, or possibly an IPO. For a few years the subsidiary boomed, riding the wave of Internet sales fulfillment. However, two things went wrong almost simultaneously: the outsourced fulfillment market changed for the worse, and the parent company became embroiled in an acrimonious and hostile shareholders' revolt. The subsidiary's Chief Operating Officer (COO) realized they had missed the window for an IPO, but thought there was still an opportunity to prepare the company for a sale, or fold the subsidiary back into the parent company and ride out the downturn. He made a presentation to an interested suitor who was willing to offer several million dollars for the company. Unfortunately, the parent company's management team thought they could do better and decided not to pursue the offer. The parent company then let the subsidiary's management team go, and eventually sold the company for under $1 million. Although they did sell the company, they got a much lower price than the earlier offer.
Lesson: Timing is important and obstinacy is not the same as planning.
Shut It Down
Every week I read about a small business closing its doors because the "new lease is too expensive", "the owner had a stroke", the owner "just got tired", or because "business was slow". Hundreds of businesses go out this way every day --- often a small shop, a restaurant, a small construction company, a shoestore, or a doctor's office. Usually there is an asset sale of some kind, and sometimes the business name is purchased by someone else for pennies on the dollar and restarted with different owners.
If a business has been around for a long time, chances are there is a substantial amount of "goodwill". In other words, the business name (or "brand") is valuable. If a business simply shuts down, this goodwill is usually lost. Even if someone offers to buy the name later, because the business has shut down, the value has dropped, and the selling price is lower than what it would have been if the business was still operating.
While "shutting down" is almost always an option, it is rarely the best exit strategy. As long as the company's brand has any value, the company has a loyal or sizeable customer base, or the company has a stable core of employees, the business owner would be significantly better off selling the company.
Another option is to just take as much cash as you can out of the business each year, while keeping enough in the business so it can continue operating profitably. This strategy makes sense where the business generates a lot of cash flow and requires little hand-holding by the owner. Examples might include certain manufacturing businesses, restaurants, nightclubs, real estate brokerages, consulting firms, and others.
While the "drain it" option may not yield the highest possible return on investment, it does have its advantages. It requires very little planning, and it can be very profitable.
However, there are a few potential disadvantages: a) If you take the money out in salary, your tax bite could be considerable. Consult with your acountant or a financial planner. b) If you are the majority owner, but not the sole owner, you could be violating operating agreements by taking out too much money, with or without paying the other owners. c) And if you take out too much money at the wrong time (for instance, just before an economic downturn) you could quickly kill the business, and still face a huge tax liability.
A sale is always an option: the question is how much can you get for your company? The key is to find suitable buyers who assign a high value to your company. Gneerally, the more potential buyers, the better, since then you can establish a market price.
Most business brokers recommend you start planning for a sale at least 3-5 years in advance. This may sound overly cautious, but in many cases even 5 years is not long enough. As a business owner it is very easy to become overly attached to your business and lose sight of what the business really looks like to an outsider. What makes your company valuable to you may not have any impact on a potential buyer.
This is when a business owner transfers ownership to family members, friends, or employees. It is still a sale, but the terms and nature of the transaction are usually very different. The fact that the buyers are close to you makes this both easier and harder to complete. Easier because you have a much better knowledge about the buyer; harder because you tend to be less objective about the buyer, and are more likely to let your guard down in negotiations and planning. Be sure to engage an experienced professional so you protect yourself before, during and after the sale. And, as with all other options, start planning early.
Although IPOs get most of the press, they are actually very rare. There were 853 IPOs in 1996, near the peak of the 1990's economic frenzy. In a more typical year the number is more like 200, or even less. There are over 5,000,000 non-farm employer firms in the United States, so in a typical year, less than 0.01% of all firms undergo an IPO in any given year.
The IPO process itself is both costly and labor intensive, and usually requires an upfront investment of over a hundred thousand dollars. Public companies have to produce detailed reports on their financials, staffing, marketing, operations, management, etc. These reporting requirements typically cost hundreds of thousands, or even millions, of dollars each year. The Sarbanes Oxley Act, passed shortly after the Enron scandal, costs even the smallest of firms several hundred thousand dollars in consulting fees. Finally, many companies are just not valued highly on the stock market. For instance, very few consulting firms go public. Because a consulting firm's assets are tied so closely to its staff, if the staff leaves, the assets walk out the door. Of course there are a very small number of firms for which an IPO makes sense, and may even be necessary. However, for the other 99.99% of us, an IPO is just not a viable exit strategy.
Preparing for the Exit
Most exit strategies benefit from preparation and planning. Consider the case of a closely held family restaurant. Suppose the owner is the head chef and his wife is the manager. The restaurant has been in business for 30 years, has a loyal clientele, and is very profitable. If the owner and his wife leave, the recipes and cooking style go with him, and the customer service and operational efficiencies go with her. There isn't much left in the business except the name. However, if the owner and his wife begin planning for a sale years before, they can make the restaurant much more valuable to a potential buyer. For instance, the chef can train one or two assistant chefs, and teach them his secret recipes and cooking techniques. The wife, who manages the restaurant, can hire one or two assistants and train them. She can develop procedure manuals (or at least define what the procedures should be). She can also introduce her protégées to regular clients so they know who they are. After a few years, a buyer could easily take over the business and keep it going as long as he is able to keep the now well-trained staff on board. By following the above steps, the owner and his wife have significantly increased the value of their business.
Larger businesses have much more at stake. The best approach is to postpone the sale for a few years, and gradually put some key elements in place to maximize the value of the company. Basically anything that increases transparency, efficiency, revenue or profitability, or decreases risk or costs, should be considered. These include
Andrew Clarke is Chief Executive Officer of Ground Floor Partners. Ground Floor Partners helps early stage, small-, and middle-market businesses grow through design and execution of sound business strategies.
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