How to Create an Exit Strategy
“How to Create an Exit Strategy”
Entrepreneurs rightly think of themselves as irreplaceable, but the inevitable day will arrive to pass the proverbial baton. Make sure you have this exit plan set well in advance, so you guarantee personal control and smooth delivery.
Entrepreneurs become so focused on serving their customers that they often neglect to plan for the company’s long-term future. They allow all of their net worth to become tied up in the company, they don’t develop second-tier management, and they don’t learn to delegate responsibility. Owners then aren’t prepared if a disaster keeps them from working for an extended period, nor do they begin planning for their own departure in time for it to occur smoothly.
In this Quick-Read you will find:
- Reasons for creating an exit strategy.
- Key considerations and timing options.
- Ways to pass the torch to another internal or external owner.
Entrepreneurs rightly think of themselves as irreplaceable. But as a business matures, the owner must prepare so the company can withstand their absence and ultimate retirement. Such a process must be considered earlier than most owners think because it can take five to 10 years to put the appropriate pieces in place. Five key steps are required to create an exit strategy:
- Decide on a target date for a change in role. The owner must decide what his/her long-term role will be, what plans must be made for retirement and when a second generation of management should be in place. In some cases, the plan may be only to loosen the reins enough for the owner to be gone for a month at a time. In others, it may mean shifting responsibility so the owner can visit the office once a week, once a month or never. The target date for this shift can change, but without a deadline in place, the plan usually is treated negligibly and resources aren’t devoted to achieving it.
- Gain feedback. Especially in a family business, the owner must learn the perspectives of others who are affected. For instance, parents should not assume a child will want to shoulder ownership responsibility, but they should pick a successor and let others cope with that choice. A family meeting held away from the business, possibly with a facilitator, can ensure all concerns are considered before a plan is drawn up. This is vital so people don’t work against the developed strategy behind the scenes. This planning can take several years to be finalized to the acceptance of all concerned, so it must begin early.
- Create the plan. Ultimately, the owner must decide what evolution will occur in the business to remove him/her from ownership and supervision on at least a full-time basis. There are three ways to change ownership of the company: sell, merge or go public.
- Sell. The owner must decide who will buy the company. Four key options exist:
- Sell to children. It must be established how they can buy it, whether through stock gifts, purchase or inheritance. In partnerships with many children among the families, finalization may take time and compromises, especially if the children don’t have the money to buy it and the owner needs cash income to retire.
- Sell to employees. This can occur via an employee stock ownership plan (ESOP), which strengthens employee commitment. However, it can be expensive to establish and may not bring the highest price.
- Sell to a strategic partner. A broker typically is used to find an appropriate company to buy the firm to enhance the buyer’s own position in the market. This takes time but can result in a high selling price and ensure the company’s continued value in the marketplace.
- Sell to a financial buyer. A broker shops the company based on its financial potential, using a presentation to attract venture capitalists. An auction also can achieve a high selling price, but only by making private financial data public and eliminating control over the takeover.
- Merge. A company too small to attract buyer interest may merge with another small company to create a larger, more significant and better-capitalized business. Two types are most typical: A tuck-under merger in which the other company receives a stake in the profits, and absorption in which the selling company becomes part of the other company (as a branch or separate division).
- Go public. This approach raises significant capital and offers strong growth opportunities, but it is not practical for a company with a value under $100 million. Public stocks also make the company responsive to outside investors and require positive results on a quarterly basis, making it attractive to plan for the short term rather than the long term. An initial public offering (IPO) also is expensive (costing as much as $500,000) and can take several years to prepare.
- Sell. The owner must decide who will buy the company. Four key options exist:
- Publish the plan. Ensure that all management and family members know the owner’s long-term goals so they can plan accordingly. This also allows interim deadlines to be set for the activities that lead to the final result (such as hiring a second in command, selling stock to new management, etc.). These deadlines are set by working backward from the final target date.
- Implement the plan. The actual implementation runs smoothly if the other four sections have been considered carefully. Be sure to include advice and direction from a financial or estate planner.
REAL-LIFE EXAMPLE [top]
When Ed Avis founded Marion Street Press in 1993, it was a one-man shop that produced the trade magazine Modern Reprographics out of Avis’ home. By 1998, the company had ten employees and annual sales of more than $1 million. That’s when Avis decided to sell.
“When we started, there weren’t any competitors," Avis explains. "By 1998, there were three competing publications with bigger staffs. We were still the leading magazine in the field, but I could feel the competitors nipping at my heels. I figured it was a smart idea to get out while I was ahead.”
Avis hired a broker who walked him through the grueling process of getting hisbusiness in top selling form. The broker "knew what buyers would ask for, and wouldn’t take anything less than the most accurate information. It helped me get a better handle on my business — I looked up profitability and competitive issues I never would have on my own.”
Avis prepared a business profile that convinced prospective buyers the magazine’s future was bright. “You have to have a plan that shows your company can grow. No one wants to buy a company if it doesn’t have the potential to get better,” he stresses.
In May 1998, Avis sold Modern Reprographics to Cygnus Publishing in New York for $1.2 million. He also received a $40,000 signing bonus to stay with themagazine for 19 months, an annual salary of $100,000, plus a two-year incentive package based on increased profitability that added an extra $220,000 to Marion Street Press’ coffers. Avis, who left Cygnus at the end of 1999 to pursue other publishing ventures, believes he ended up a half-million dollars ahead thanks to his broker (who charged 5% commission). “I would have taken $1 million,” he says. “I’m confident he helped us get the optimum price.”
DO IT [top]
- Have the company valued to determine its worth. This must be done if any stock will be changing hands as part of your exit strategy. It also will help determine which sales options may be most viable. The Quick-Read "How to Value Your Company," provides guidance to help you get started.
- Evaluate what would happen to your company if you could not operate it for an extended period. Determine what steps to take to ensure that it could progress if the owner was not available. Such a contingency plan is not a succession plan, but it can be just as important.
- Consider if your long-term plans involve staying in contact with the business even after day-to-day involvement ends or if you want a clean break. (Your successor also may have an opinion on this.)
- Talk to your spouse about his or her considerations for retirement, especially if he or she works in the business.
Another Kind of Hero: Preparing Successors for Leadership by Craig E. Aronoff and John L. Ward (Business Owners Resources, 1992).
Family Business Succession Handbook edited by Mark Fischetti (Family Business Pub., 1997).
Lisa J. Miller, CPA, of Colle & McVoy Inc. in Minneapolis, Minn.
Writers: Craig A. Shutt and Kathy Furore