By Vicki M. Daughdrill
Small Business Resources LLC
In "Who will take your place?" The Green Sheet, Feb. 23, 2015, issue 15:02:02, I discussed the need for a succession plan that develops qualified people to assume key roles when a company's current leadership cannot or no longer wishes to run the business. Another important consideration is how to exit a business in a way that serves the present owner's needs, as well as those of the other parties involved.
According to the Small Business Administration, Office of Advocacy, a small business is an independent business having fewer than 500 employees. In 2011, there were 28.2 million small businesses, and over three-quarters of these small businesses were nonemployers. Home-based businesses comprised 52 percent of small businesses, and 72.1 percent of these were classed as sole proprietors, the SBA reported.
With 99.7 percent of U.S. businesses having fewer than 500 employees, only half of new businesses surviving five years and only 33 percent of new businesses existing for 10 years, it's important to think about an exit strategy from the first day of business. Also, at the time you initiate your business, decide if you are operating a lifestyle business (a way to support your lifestyle) or creating a way to build wealth and to provide a business to turn into cash at some later date for retirement income or other purposes.
According to Wikipedia, an exit strategy is a means of leaving one's current situation either after a predetermined objective has been achieved or as a way to mitigate failure. It's a way to transition one's ownership of a company or the operation of some part of the company. Exiting entrepreneurs and investors devise ways of recouping the capital they have invested in a company. This is also the time to plan an efficient transfer as related to possible applicable estate taxes, capital gains taxes, or other taxes.
A business owner can become incapacitated or die, the company may fall onto hard times and face bankruptcy, or an owner may simply be ready to retire. Each of these triggers can lead to a different exit strategy. There are five major exit strategies to consider based on the company's particular situation.
The sale of the business to another entrepreneur or company is the most common way owners exit their businesses. This is a process that can be a simple transaction between two individuals without government regulation and oversight or as complex as creating an initial public offering (IPO). Sale of the business generally results in an exchange of cash for the assets of the business.
The most challenging part of a sale is the valuation of the company. There are a number of factors to consider in valuing a business, including how long the business has been in operation, the number of employees, the facilities, supplies, inventory and its overall condition. In addition, there are at least three methods of valuing a business: asset-based, market approach and income approach. An accredited business valuation specialist can determine the correct factors and the appropriate valuation method to utilize in valuing the business.
Mergers occur when two companies combine to form one larger company. Cash is rarely exchanged in this type of exit strategy. Generally, stock is issued in the newly formed company and is considered to be worth more than the stock in the two previously independent companies. In many cases, it's years before any cash is withdrawn through the sale of the stock in the new company.
An initial public offering (IPO) is a sale of a company via the stock market. This exit strategy is generally for businesses with revenues in excess of $50 million. While this method of exiting the business can generate the largest cash payout, it is extraordinarily expensive and can easily cost upwards of $1 million to complete. This method is generally not used by owners of small businesses.
Small to midsize businesses use a management buyout strategy for owners to exit the business. The buyers may be current employees of the business, another business owner in a similar line of work, or an individual who is simply interested in the business' products and services.
The thing to remember in this type of strategy is that the buyout is frequently tied to performance at the time of the buyout and ongoing for a period after the buyout. The best method for executing this kind of exit is through an upfront cash buyout rather than through a leveraged buyout, where payment is made over time using the business revenue to pay the buyout.
A company without any debts can simply liquidate the assets and close the business. Again, pricing any assets requires a valuation to achieve a negotiated fair deal for both buyer and seller. This method of exit usually generates the smallest amount of cash at the time of sale and is appropriate for business owners who operate a business that supports their lifestyle and was not intended to build wealth or provide funds for retirement.
If the business is technically bankrupt, meaning there are more debts than assets, a forced liquidation may occur. This happens when the creditors force the business owner to sell off assets to pay debts. In this case, the business ceases operation if it has not done so already. Generally, no income is generated for the owner
As you evaluate the future of your business and you determine whether you will want retirement funds as you exit the business, take time now to craft an appropriate business exit strategy. Carefully structure your plan to define your liquidity needs and what is available from exiting the business. Then take the necessary steps to restructure your business to meet future needs.
Vicki M. Daughdrill is the Managing Member of Small Business Resources LLC, a management consulting company. E-mail her at email@example.com or call her at 601-310-3594.
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