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Which Exit Route Is Right For You?

One of the keys to getting the most out of your business is to make sure you understand how important it is to consider your exit options. It doesn’t make sense to put so much into something only to not realize its highest and fullest value potential – as you define it – when it’s time to exit the business. The following discussion is part of a larger process designed to help you get the most out of your business now and in the future. There are several different routes to take when transitioning or exiting a business.

Business Exit Planning Strategies

  1. Transfer the business to a child or family member
  2. Sell to a third party
  3. Sell to one or more key employees
  4. Sell to employees using an ESOP
  5. Sell to one or more co-owners
  6. Retire without selling the business, the No Exit Exit™
  7. Engage in an IPO
  8. Liquidate

Let’s explore some of the more common routes.

Transfer to a family member

Up until very recently, we found that the most common route was transferring the business to a family member. In the best cases, the transfer could take place during life through a sale or estate/wealth transfer planning technique. Or in some cases, it would be a planned transfer at death with funding and planning in place to make sure that everything happens in an efficient and effective manner, without business disruption.

Over the past few years, though, family member transfers have become much less common, and I think that’s true industry-wide as many have found success to be extremely difficult. For one, less cash is typically available for the business owner at retirement. Often the retiring owner has to rely on the business for financing that retirement over time, risking financial independence and keeping him tied to the business after the transfer.

Also, many times the children aren’t up to the task or they are unwilling to take over. And difficulties treating children equally causes tension and concern since more than one child might be in the business. Maybe some have more ability than others, or there may be children outside the business, and treating everyone fairly becomes a huge obstacle. We talk a lot with our clients about how fair isn’t always equal and equal isn’t always fair.

If an owner does have children who are willing and able to take over the business, and she doesn’t mind staying involved, this can still be a worthwhile and attractive route. The owner transfers the company to somebody they know well, someone who understands the character and the goals that the company and who can carry on its mission. Also, the owner can provide for heirs or family members by providing a business that produces income for them.

Sale to a third party

Currently, the most common route for our clients is a sale to a third party. This is most often the best way to get the highest purchase price. Typically this creates a lot of cash at closing and the owner is in control of his departure date. This allows the business to grow at a much faster rate because no financial risk has been transferred to the buyer; i.e., no more signature guarantees on the business debt.

The third-party sale does have some drawbacks. Seller’s remorse and a loss of identity often accompany the immediate post-sale timeframe. The company also risks a personality and character change in the hands of its new owner, and employees are possibly in danger of losing jobs or at least some career opportunity. Another negative is a large part of the purchase price could hinge on the future performance of the company after the sale. However, most of our clients want to explore this route in detail, with many eventually working through a business auction process.

It is critical that this route include a plan for keeping key management. I’ve heard many times from buyers and investment bankers as well, “it’s all about the management”. Oftentimes, if key management isn’t staying, the valuation of the company will be significantly lower. In a private equity sale to an investment group, often the owner is staying on while leaving some of his equity in the business. That one difference, key management or seller staying on to grow the business, can make a world of difference in the purchase price received by the seller.

However, if the buyer is what is known as a strategic buyer, current management is not nearly as important. The difference between a strategic buyer and what we call an investor buyer (often a private equity group) is that strategic buyers are usually companies in a similar business and want to buy the competition or purchase a company to move into a new or complimentary market. They typically feel good about their management team and plan on replacing all or most of the seller’s team. In contrast, an investor buyer then, is one who is buying the company as an investment and is typically reliant on current management.

Sale to a key employee or a co-owner
Another common way to exit or transfer a business is to sell to a key employee or co-owner. These two methods can be similar. In this case, the business dollars typically fund the buy-out and so the buy-out is not as rich in valuation. If it’s anticipated and there are some contingency plans in place, this can work very well for all parties.

Selling to key employees or co-owners is similar to selling to a family member. There may not be much cash at closing and creates more financial risk because key employees and co-owners typically don’t have the wherewithal in most cases to finance the acquisition of the business on their own. Typically the business owner is doing that himself. Many times the exiting owner must stay involved post closing, and many times the employees just aren’t willing to assume the risk of owning a business or frankly are not able to do it.

If the owner is willing and able, and the exiting owner doesn’t mind staying involved, there are several advantages. The company goes to someone who the owner knows and trusts to carry on the character and goals of the company. The owner can remain as involved as he wants and he is able to provide financial security for himself and the employees that he cares about.

Combination third party, co-owner
What we see even more often nowadays is a key employee or co-owner purchase along with a third party investment group buyer or private equity group. The new group is buying, but the co-owner is also part of that new group.

This has been a very effective means of generating a high purchase price, taking some risk off the table and retiring older shareholders. It can be the best of both worlds because the co-owners who are staying with the business are typically operationally involved and key to the company, allowing the departing owner to get the highest valuation and cash at closing upon exit. The business gets money put into it by the private equity group and the group also takes the risk off the owner’s plate.

While there are complexities, we see many home runs when this occurs.

The No Exit Exit™

The final option to really consider is what we like to call the No Exit Exit™. This is a way to retain ownership, but become passive operationally; a way to retire without giving up the company.

Let’s first address the drawbacks. First, the owner isn’t getting a clean break since he is not really trying to leave the business. He becomes much like a private equity group. He is taking the financial risk of owning the company but relying on its management to make it successful. There’s an inability to create continuity in some cases and the owner doesn’t receive cash at closing since no closing exists.

However, the owner could really do well financially. It’s generally hard unless you’re going to go public to get the valuation you want for your business and oftentimes the business can be kicking off a lot more cash to the owner than he could get if he had the same value in basket/portfolio of public market investments. The ongoing income for the owner could be much higher than it would be otherwise.

Another positive to this is that he can retire gradually and insure that the character and the mission of the company are preserved.

What makes any of these methods successful for the client is how the advisor carries out the plan. We focus on educating our clients about the routes so that they can choose the most appropriate one. We go through a careful process with them, starting with conversations to discover their goals all the way to executing the arrangements and getting the people and financial products in place that make the transfer possible.

For most business owners, this will be the single biggest transaction they make in their lifetime and it involves so much more than just money.

For a reference guide to exit routes, call us at 512-472-9033 or email us at info@lwmg.com and we will send you a copy.

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