Exit Planning Explained: Different Strategies and their Unique Benefits

There are several ways one can exit a business. So how do you know which is right for you? It starts by carefully determining your goals and objectives, both personally and professionally. This is where it starts to look different with each owner. Is your ultimate goal to continue the legacy of a family run business by handing down to the next generation? Or is it to enter a “work optional” lifestyle where you finally monetize all the hard work you put into the company and take away all, or some, of the liability associated with running a business?

Whatever your objective is, determining and discussing the goals with your family is highly recommended. Once you have done this, you have already narrowed down your exit strategies..

Below I list and describe a few of the top Exit Strategies over the last several years. I will highlight some of the pros and cons of each to help you determine which may be best for you.

Family Succession –

Transferring ownership of the business to family members is one of the most common strategies we see today. Studies show 50% of typical business owners would like to hand down the business to an heir or family member, but not even a third actually do.

This is a popular strategy for owners which allows them to have more control in how the deal is structured. They can stay actively involved as long as they see fit, providing an opportunity for younger family members that they may not have outside of the family business. For most, it accomplishes the goal of keeping the business in the family.

But why is there such a low success rate? Unfortunately, trying to navigate this process often leads to family discord over perceived unequal treatment and unseen expectations. Usually the owner must owner-finance the sale (typically at a discounted valuation) as the younger generation does not have the cash or borrowing power to purchase the company. Lastly, one of the top concerns is that the owner’s payout is tied to the future success of the business, and the survival rates of second and third generation businesses are dismal.

Sell to a Third Party (Controlled Auction, Strategic or Financial sale) –

Typically, a business owner will sell either at a premium or a discount. If your business is squared away and you are looking to get the most bang for your buck, selling to a third party, where top premiums are being paid, may be the best route. If you have the opportunity to work with an Investment Bank, they can take you through what’s called a Controlled Auction.

A Controlled Auction is Investment Bankers creating a competitive market for the business by soliciting a large group of interested buyers in the industry. The owner informs the Investment Bank of a “floor price” at which they would not like to sell. Then, the company is taken to market without an asking price; the Investment Bankers entice excitement around the business and create a bidding frenzy in hopes of driving the price higher and higher.

Other, more common, transactions occur via a Strategic or Financial buyer. A Strategic Buyer is typically a larger company in an industry growing vertically or horizontally through acquisitions. In some cases, a Strategic Buyer may purchase a competitor company in order to eliminate competition. More recently, we are seeing a large amount of transactions from business owners who receive unsolicited offers out of the blue from strategic buyers. More often than not, the business owner is not prepared internally with their business and ends up not receiving as high of a valuation as they could have received.

Private Equity groups, institutional investors, and professional buyers make up your average Financial Buyer. Traditionally these buyers do not offer as high of a premium as Strategic buyers, due to the fact that Strategic Buyers benefit from market share, synergy between the two companies, as well as other perks.

However, Private Equity groups are more recently building portfolios with companies in a targeted industry, making key acquisitions to further build on market share within the industry. Essentially, they become a “quasi-strategic” buyer and pay the same or more than traditional strategic buyers.

Refinance or Recapitalize the Business –

Refinancing may be suitable for a business owner who desires to participate in the company’s growth, but would also like to diversify risk. The owner may be able to leverage the company’s assets as well as take out debt to provide partial liquidity.

If an owner feels he or she needs additional help to further grow and scale the company while simultaneously taking some chips off the table, a minority or majority recapitalization is a feasible strategy. Numerous Private Equity groups possess the capabilities and expertise in management to help small business owners struggling to grow the business or take it to the next level. The owner, in effect, monetizes a portion of his business, while adding a partner who is proficient at scaling the business. Here’s a quick example:

ABC Tech owner John Smith sells 80% of his business to a Private Equity group at a valuation of $10,000,000. John gets $8,000,000 (80%) and retains 20% ($2,000,000) ownership. The PE group comes in and does what they are supposed to do, growing the business to a valuation of $17,500,000,taking the business to market. John’s 20% stake in the company is now worth $3,500,000.

Sell to Other Shareholders –

You may have a ready market at hand if there are additional partners in the business. Since they are already in the business and know the pros and cons, there is typically less convincing needed. A “best in class” business should have a buy-sell agreement already in place directing what happens when a partner wishes to exit. When an acquiring partner already owns a certain percentage of the company, they are more likely to raise the capital needed to buy out the remaining shares. Whether it be raising funds from a Financial buyer, or obtaining a loan from the bank, this strategy can be one of the more clean and efficient ways to exit.

Management/Leveraged buy-out (MBO/LBO) –

An MBO or an LBO are very similar to selling to a shareholder, as you may have a ready market interested in buying out the owner. This is only an option if you have a strong management team or key employee in the company. The management team brings in a Financial buyer to help buyout the existing owner and also possesses the potential to arrange for additional growth capital in the future. This strategy may also decrease the likelihood of any disruption in performance or loss of key employees in the company, which bodes well for all parties.

Employee Stock Ownership Program (ESOP) –

We often come across owners who do not want to sell in regards to what may happen to their employees once they exit, or they simply would like the employees to benefit from a sell, rewarding them for their hard work in helping grow the business. ESOPs have been around for several decades now, but have dramatically increased in popularity in recent years. At the discretion of the owner, an ESOP is formed by establishing a trust in which the company borrows funds to buy out the shareholders. The owner’s shares are then placed into the trust and are distributed amongst the participating employee’s accounts. The loan inside the trust is then repaid by distributions of the company’s profit. A big point to make here is that the shares are bought with pre-tax dollars!

A few other notable points are that ESOPs are one of the few times a business will sell for the Fair Market Value of the business. The business owner does not have to sell all of his shares into the ESOP. Similar to a Recapitalization, an owner can take some chips off the table and still be able to work in the business, maintaining a desired equity percentage in the company. Lastly, one of my favorite features of an ESOP is it instills a sense of ownership in the employees; as they become shareholders, they increase their work ethic which results in a more profitable company.

Go Public –

If your business is at an appropriate size and in need of substantial growth capital, conducting an Initial Public Offering (IPO) is an excellent way for the owner to exit a business. Often, this is the ultimate goal of most entrepreneurs. Unfortunately, this is not a viable or realistic option for the vast majority of business owners. As mentioned previously, while the benefits of taking your company public are numerous, you must have a great track record of substantial growth along with considerable revenue and earnings. Also, it is equally important the business is able to show that it can grow in scale.

After reading this you may have changed your idea of selling to an ESOP to seeking the biggest bang for your buck by bringing in an outside buyer. Or maybe you have learned that handing the business down to the next generation is not as easy or successful as you had hoped. For most readers, you may be thinking you do not need to start planning for this now or for a while. However, I strongly advise every private business owner to ensure your company is always ready for an exit. Educate yourself now and know your options. Your business could change, for better or worse, in the blink of an eye. Start planning today for your eventual exit to ensure you achieve your desired outcome.

J. Tyler Thompson, CFP^®, CEPA^®, AAMS^®, WMS^®

CERTIFIED FINANCIAL PLANNER™

CERTIFIED EXIT PLANNING ADVISOR^®