You Will Exit Your Business; Here's Why You Need a Plan Now
Did you know when you start your business, you should also plan your exit strategy? Don’t panic.
Here with some wisdom and the skinny on this very important step is Jack Harwell, a business adviser with the Kansas Small Business Development Center at Johnson County Community College. He’s a supply-chain guru who has more than 30 years of experience with the inner workings of businesses—in short, he knows a thing or two … or eight … about exit strategies, why they’re important, what your options are and what you should think about when planning your exit.
Jack says in certain markets, there will be big winners and big losers. Who will likely be the winners? The entrepreneurs who planned for their exit, he says.
If you’d like to plan your own exit strategy or just wonder what's the next step for your business, KCSourceLink can help you reach the next stage of your entrepreneurial journey. Tell us a bit about yourself or call 816-235-6500, and we'll set up your free Personal Action Plan.
KCSourceLink: If an entrepreneur is just starting his or her business, what's the benefit of creating an exit strategy?
Jack Harwell: Owning a small business means owning an equity investment that pays dividends (hopefully). With this in mind, I like to think about the owner’s business as a component of their retirement portfolio. There needs to be some plan for what the long game is in terms of that portion of the portfolio and how it fits into the whole. Also, people tend to be more successful when they have the end in mind.
KCSL: When should entrepreneurs think about planning their exit strategy?
Jack: They should start planning their exit while they are planning to start their business. These plans should be continuously updated over the life of the business.
As the exit approaches, the owner can do many things to enhance the value of their investment and improve the outcome. Some exit strategies take as much as five years or more to execute, so I would recommend at least a minimum of three to five years to formalize the exit strategy.
The legal structure of the business (LLC, S-Corp, etc.) can also be a factor in how much tax is paid as a result of the transition. Because there are tax implications when a business changes its structure relative to the exit, some money may be left on the table if it’s not timed correctly, so planning at least five years in advance may have some tax advantages.
That said, there is always the chance that something unexpected could happen, like a “bluebird” offer from a strategic buyer. If the owner isn’t ready, he or she may not be able to capitalize on the opportunity. So always be ready to exit. Also, risk management is a component of a good exit strategy. Planning what happens if the owner is disabled or dies and funding a transition with insurance is key to salvaging the value of the business when the owner can no longer run the business.
KCSL: What are some common exit strategies?
Jack: There are four basic strategies to exit your business:
- transfer ownership within the family
- sell internally (employees or partner)
- sell to a third party
Within these strategies, there are several variations on the theme. An internal sale, for example, could be an ESOP, a management buyout or a partner purchase. A sale to a third party could be to a strategic buyer or on the open market.
KCSL: What objectives should an entrepreneur have when looking for an exit?
Jack: The owner’s objectives for the exit dictate which strategy is best for the circumstances. There are considerations for whom or what the owner wants the transition to benefit and how he or she wants to be involved in the business going forward, if at all.
Also, the tax implications of each exit strategy are different and are usually one of the biggest drivers for choosing which strategy would be best.
Liquidation is the default strategy and is almost always the least favorable option.
KCSL: How would an entrepreneur determine the best exit strategy for their needs?
Jack: For the best results, most exit strategies need the support of several professional services, including an attorney, CPA, financial planner, banker and insurance broker. These providers should be experienced in business transitions, so they may not be the same people the owner uses to help run the business. The plan may also need input from other specialists, like a family business counselor. With so many players, it makes sense to have a resource that’s knowledgeable about the entire process to be the quarterback of the team. A Certified Exit Planning Advisor, or CEPA, is trained to coordinate all pieces of the exit strategy and make sure all providers are working on the same plan.
Starting with the objectives, the exit-planning team will map out all aspects of the transition and design a strategy that’s tailored to the specific situation. There is a complex set of issues to think about when developing the strategy, so I recommend that the owner works with an exit-planning advisor to develop and execute the strategy.
KCSL: What are some important considerations to make when planning that exit?
Jack: An owner can do many things to enhance the value of their business before the transition. The value-enhancement part of the exit strategy is where opportunities are identified and action plans are created to address them. These can take a significant amount of time and resources but can also lead to a much higher return on investment.
There are many ways to estimate the value of a business, and each depends on the assumptions and opinions of whoever is doing the valuation. The buyer ultimately decides the true value of a business. When deciding what to pay for a business, buyers are really making a risk decision on what the business can yield in cash flow for them. Many factors go into buyers’ decisions of what to pay, including capital markets, other opportunities and more.
Similar to the overall economy, the market for businesses ebb and flow. A strategy needs to contemplate these dynamics.
Baby Boomers own 66 percent of privately held businesses, according to a survey from the Exit Planning Institute. Additionally, 80-90 percent of these owners’ wealth is tied up in their businesses, and 76 percent plan to exit in the next 10 years. This represents an estimated $10 trillion in capital changing hands in the near future. The capital markets simply can’t support that level of activity. So I anticipate a buyer’s market, which implies there will be big winners and big losers; those who prepared are more likely to come out as winners.
KCSL: What are some common misconceptions surrounding exit strategies?
Jack: Many owners don’t have a good idea of what their business could be worth. In many cases, they overestimate its value. This can end in terrible disappointment down the road when they start their transition. Part of the exit-planning process is to baseline an estimate of value and then do periodic valuation checks to make sure the plan is on track.
Another misconception is that an exit can be planned and executed in a matter of months, if not weeks. As I mentioned before, business owners need more time to optimize the results.
KCSL: What resources in the KC metro are available to entrepreneurs looking to craft their own exit strategy?
Jack: The Kansas SBDC has a CEPA on staff who can assist small-business owners with the development of their exit strategy. Kansas City has many professional services providers that can assist with their portion of the exit strategy, and the Kansas SBDC maintains a resource list of providers that have experience in business transitions.
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Image courtesy of Pat Guiney CC BY 2.0.