Exit Strategy: Do You Have a Roadmap to Success?

There are many business owners today that are approaching the RoadMapfinal phase of running their business where they have to consider how they are going to exit (leave the company) and on what terms. While there are many scenarios that can be played out there are at least three key questions that come into play:
1. What options are possible: sale or succession?
2. Is the company positioned for an owner exit event?
3. Will the exit strategy support the desired, after exit, life style and for how long?

The typical owner facing this decision is in their mid to late 50’s, targeting an exit event in their early 60’s. They have worked hard year-to-year to make the company successful while affording them a reasonable income. Even though the company is a success and has provided a comfortable living the business may not be ready or positioned for a successful exit event.

Exit Options
An owner can exit in a number of ways, ranging from selling to a third party (public or private business), or management buyout, to include an orderly transfer of control to succession management. Let’s look at each of these options and the corresponding risks that may be present.

Sale to a Third Party
Selling ownership interest to a public or private company may result in a total cash buyout, but more likely it will be a mixture of some cash and the rest stock in the new company. This has advantages to both sides allowing the buyer to conserve cash and for the owner to reduce their tax exposure. The primary question for the owner selling is the marketability of the stock (public or private) and the risk of how the new company management team will influence the value of the stock.

It was customary to offer the owner a consulting contract or earn out to insure a successful transition. Unfortunately, this method has decreased over time since it is not easy for many owners to accept and adopt the new business style of the acquiring business, complying with changes in strategy and process, and the personalities of the new management team.

The owner’s equity now represented in new company stock is exposed to the management ability and economic cycles of the new company. Depending upon the value of the stock involved, few owners would look positively on letting another, unfamiliar, management team be responsible for sustaining and increasing the value of their equity, now represented by the new company stock.

This situation is more complex if the buying company is private which limits the marketability of the stock and value at which the stock will be traded for cash. The owner is then at the mercy of the new company’s policy on buying back stock (price, amount, schedule).

Management Buyout
A management buyout is where a number of the key executives mortgage their assets and a significant amount of future income to buy a controlling, if not complete interest, in the company from the owner. If the executives have enough borrowing capacity, they may buy the interest outright. If not, then the owner may carry the note but will retain a controlling interest until the note is paid or sufficiently repaid.

The owner may have to come back into the company if the buyout team falls apart or is unable to run the business successfully to produce the income to meet the loan payment schedule.

Succession Management
Turning control over to succession management allows the owner to remain in control. The financial impact on the company is less than a management buyout other than increasing the financial incentives for the management team. The company is not under the same pressure to divert cash to the owner like in a buyout. The financial pressure is less, but the owner in this scenario has to rely upon distributions of year-end earnings to minimally support their desired standard of living.

First, if the owner needs to rely upon a future distribution of earnings then they will be exposed to the economic cycles of the business, which could result in a major reduction in distribution amount, possibly down to zero.

Secondly, the future success of the business will depend not only upon the operational effectiveness of the succession team but also their entrepreneurial acumen and skill to deal with unexpected business events and opportunities.

Company Position
Organization Depth
A business that is ready for an exit event has taken the time to prepare. Efforts have been made to develop the organization to run the day-to-day operations independent of the owner. If the owner chose to run a closely held business, their departure will impact the operation of the business significantly. The right management talent and skill in making decisions will not be developed since the owner held many decisions and responsibilities under tight control.

A forward-looking owner will realize the need to develop subordinates who are capable of making strategic decisions and operating the business successfully through up and down business cycles. Over time, significant decisions will be delegated to key managers with the owner taking on an advisory role. The management team matures and becomes the driver of the business.

Financial Performance
A company should not only have a successful track record of financial success but a strong balance sheet as well. An owner will want to benefit from a prospective buyer seeing the certainty of a return on their investment. A financially strong business will allow the owner to argue a premium value for their ownership in the business.

Strategic Position
A business that has established a strong strategic position in the marketplace with customers will attract buyers. Customers that view a product or service as strategic will recognize value and will often pay more for it than other competitive sources. Consequently the business will have stronger margins and a brand that would assist the buying company to introduce their products or services to the seller customer base. Another option is to use the strong brand of the old company to improve the competitive position with customers of the buying company.

After Exit Life Style and Retirement Planning
It is common for the owner of a private company to have an inflated view of the value of their company and to underestimate the walk-away amount they need to support a comfortable lifestyle. Retirement planning is an absolute element of the plan to sell a company as well as understanding the tax consequences that will apply.

A major participation in the retirement planning process should be the spouse, partner or significant other to make sure there is not a misunderstanding of the standard of living expected upon retirement. Retirement planning and setting up retirement investments should be a priority during the owner’s work life to soften any shortcomings that might occur as a result of the sale. It is always easy to deal with too much money, more than you had planed, but not so easy to deal with a short fall and disappointed expectations at the end of your work life.

In the past, living off of a retirement reserve with interest rates of 6% to 8% allowed many to retire in style and live off of the interest and not touch the principle investment. Recent economic cycles have demonstrated that this type of experience cannot be relied upon. With annual interest rates dropping below 2% you are no longer living off of interest and valuable principle is consumed in order to meet financial needs.

The exit strategy a successful owner from a company is a complex process. Many businesses fold or significantly downsize a few years after a change in ownership. This is not only due to faulty acquisition processes by the buyer but also failure upon the previous owner, if they have not properly prepared the business, for their departure.

Preparation is fundamental to maximizing the value of your ownership. You can hope for a white knight or buyer that is not well informed to write you a big check. It can happen but it would be like winning the lottery – your odds are not good. Selling your ownership needs the same attention to detail that a new product introduction involves. Remember you are selling a product – your company.

Identify and develop your roadmap to success. Seek input from others – peers, professionals, company executives and your spouse. Don’t leave it as something that you will get to. Develop a plan that will develop the necessary conditions, as described above, to let you exit the company on your terms and enjoy the lifestyle you desire.


Note:  You will find additional information on this subject at Exit Planning: Plan or Accident.

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