Developing an Exit Plan for your Business
Everyone has an exit plan for their business. The thing is, it just might not be your plan. Eventually, there will come a time when you will either have or would like to step away from your business. In 90% of cases, people come to me far too late to do anything to effectively exit their business. They end up getting pennies on the dollar for what their companies could be worth.
Effective planning for an eventual exit is critical to success. This will help you ask the right questions for an exit event.
What's your time table?
An introductory question for deciding how to exit your business is when you would like to exit.
If you're trying to make this event happen in the next 12 months, and you've done no prior planning, you're going to be in for a rude awakening. Most exits take years, not months. The faster you try to rush this process, the lower your valuation will be.
If you've done absolutely no planning, give yourself at least 2 years to flesh out the process. Ideally, shoot for 3-5 years out, which will give you the best opportunity to build a higher valuation.
Who's your buyer?
You're probably used to selling your products or services, and selling a business can follow similar mechanics. Admittedly, it is a much bigger transaction than you've probably handled before, but the concept is similar.
Your first step should be to define the target market for your business. Common potential buyers include
- Family members
- Independent Third Parties
- Private Equity
- Public Offering
A transition to a son or a daughter is one of the most common exit plans. As a practical matter, many of these transitions are glorified gifts. This might be a friendly way to pass on the business, but if you were ever counting on a major cash-out when you sold the business, you might be disappointed when your offspring simply don't have the funds to pay you what you think the business is worth. Many of these transitions are done rather informally, which can also lead to legal and tax issues down the road. For instance, if your company does have significant assets, the transfer of your business could trigger gift tax.
Current key employees might be the the ideal candidate for taking over your business. They know the processes and systems, but they might not have the cash available to buy your business. Getting financing for an employee to purchase a business is often the most difficult hurdle.
Independent Third Parties
There are plenty of people that are interested in investing in successful cash-flow businesses. The problem is finding them. Many of these investors work through business brokers to find businesses worth buying. However, these people are more sophisticated than employees or family members, and they will expect you to be able to justify your valuation. If you're planning a quick exit, these guys will take advantage of your haste, so plan ahead.
Institutional investors might be the ideal opportunity for you cash out some equity in your business. However, institutional investors like private equity companies and venture capitalists are passive investors with great expectations. They'll usually expect you to continue working in the business, and they will want significant returns on their investment. If you're expecting these "passive" investors to be "passive," you'll be disappointed. However, if you're looking for someone that can take your business to the next level, private equity can get you there.
Some companies might have the opportunity to "go public," which means that a share of the company could be sold to the general public like on a stock exchange. Going public is a significant undertaking, but, if done properly, can flood your company with all the capital it needs.
What is my business worth?
How much is a house worth? It depends. How much is a business worth? It also depends.
At a minimum, your business is worth the sum of all of the assets the company owns. If the company has debt, that debt is subtracted from the value of the assets. This amount is the company's Book Value. The Book Value of your company is essentially what the company is worth in a garage sale, but because this value is pretty easy to calculate, it's a more reliable method of valuing a company.
If your company consistently earns profit, especially if that profit is generated off of reoccurring revenue or guaranteed contracts, your company can receive an additional valuation in consideration of this consistent revenue. However, this Market or Income valuation is much more subjective. Further, if your net income after expenses is negative, even for a relatively short period, this might eliminate any value your company might have.
What mistakes do business owners make when planning their exit?
The mistakes business owners make exiting their business could fill a book. Here are a few big ones:
- Waiting too late to plan: Trying to sell a business in a pinch is like selling real estate that is mid-construction. You're going to need time to exit, so start planning early.
- Mistaking income for profit: A current trend, especially in the tech industry, is the tendency to value on gross income. This provides a deceptively high and inaccurate value of a company. It doesn't matter how much your company makes if there isn't anything left over at the end of the day.
- Getting emotional: Your business might be your baby, but to a potential buyer, it's no different than buying stock in a public company. An investor doesn't care how much time you've spent building the business, they care about returns. Be sure to speak their language.
- Focusing on "Vanity Metrics:" Net cash flow, most often calculated at EBITDA (Earnings before interest, taxes, depreciation, and amortization), is the gold standard in business value. Daily site users, impressions, etc. are vanity metrics that are virtually worthless without core earnings.
- Trying to wing it: Exiting a business triggers numerous legal, accounting, leadership, and tax hurdles. Each one must be independently addressed to ensure a smooth transition. Many businesses try to DIY an exit, only to find that they made minor errors that resulted in significant adverse effects.
- Not getting good advice: A knowledgeable team of advisors, including a lawyer, accountant, financial advisor, and banker, can more than earn their expense in an exit. Not only will these advisors be able to mitigate risks, but they are often able to add value and negotiate a better deal than you might get on your own.
How do you start planning to exit a business?
The first step in any exit plan is to create a plan. To create the plan, you'll need a team that can help you ask the right questions. Once the plan is in place, the team can then help implement and execute that plan. Do not hesitate to seek out knowledgeable advisors early in the process, as they can save you months of effort on the back end.
If you're ready to start building your exit planning team, The Watson Firm can help. We have assisted numerous clients create exit plans, find potential buyers, and exit successfully, all while limiting their exposure and maximizing their returns. We have also helped to build the teams necessary to create and execute exit strategies. Contact us by completing the form on the side of this page or by calling us at 205.545.7278.