Learn more about the important factors you should consider when planning your exit strategy.
Develop an exit strategy.
When your company was brand new, time and energy were the only true commodities you had. You put in long hours and grew the business. Perhaps your company has grown from a one-person office in your home to a multi-layered entity with a management structure and a commanding presence in the marketplace.
As a successful small business owner, you know the value of planning and developing strategies for your business. If the question of someday selling your business has entered your mind, it’s a warning that you need to begin developing a new strategy for your business: an exit strategy.
Selling your business can be a drain on precious resources such as your time, money, and emotions. Day-to-day operations of your business require focus, and it is extremely difficult to run a company and simultaneously prepare for and execute its sale. It is wise to turn to a professional adviser to help you through the process of selling your business.
Most business owners have one need in common — control of the business. Discussing the possible sale of your company can be nearly as awkward as discussing your marriage with a marriage counselor. Who knows more about what you’ve been through with your company? Who would understand the anxiety associated with selling something so personal to you?
The thought of giving away the control of your business can actually cloud your vision and sway your focus away from running it. It is important to seek help from a professional who will be on your side, looking out for your best interests, but who can remain objective when it comes to the potential sale of your business.
Start with the professionals with whom you’ve worked while you built your business. Ask for referrals and recommendations from your banker, lawyer, or accountant. However, remember to be discrete in order to ensure confidentiality—you do not want your employees and customers to hear about the potential sale of your business before you’ve even started to test the market.
When searching for the right adviser to help you sell your business, ask the right questions. What are the previous deals he or she has successfully completed? Does he or she specialize in specific industries? More importantly, does he or she have experience in your industry?
Business brokers can search and identify demand within the marketplace. The sale of a closely-held business normally has a much tighter market than that of a publicly traded company since the criteria for purchasing and the steps involved often greatly exceed that of a stock exchange. A qualified business broker or adviser will have contacts throughout the country, which can help create a market for your business.
Another important factor to consider is the broker’s fee structure and what additional services he or she provides. The best scenario is hiring an adviser who will actually coach you and work to strengthen your business at no additional charge, while working for a fee, such as a percentage of the closing sale price. This is a win-win relationship since you may receive a higher sales price for your business and your broker or adviser will capture a higher commission fee. In short, the adviser will have a stronger incentive to get you the best price for your business.
While earnings and sales will normally be the driving forces behind the sales price of a business, other factors may also be heavily weighted in a potential buyer’s eyes.
Consider service contract companies, for example. Buyers normally review the quality of earnings—specifically, how long the contracts have been in place. They will consider how many contracts the company holds, whether they are equally distributed, or if a few large contracts make up the majority of sales. They will also look at the renewal of the contracts.
All of these questions will be addressed to allow for the prospective buyer to estimate future earnings based on the quality of the given contracts.
In general, most service companies are bought or sold based on their gross margins and often they are compared to companies of similar size within their industry. Buyers may be looking to purchase the contracts and use the current direct labor of the business without much regard for the company’s overhead.
The idea behind this strategy is that a large piece of overhead can be absorbed with the buyer’s current business infrastructure. It is important to partner with a broker or adviser who is familiar with your industry because he or she will be able to identify these issues from the start.
Synergies, or excessive costs, that will not be necessary under new ownership can work in favor of the buyer or the seller depending upon many factors, including the potential buyer’s willingness to purchase, the industry, and how well the negotiations are executed.
A seller can use the reduction in direct and overhead expenses and hidden “owner expenses” as a way to reconstruct the earnings. This would increase the net income of the business and command a higher selling price. Some sellers would miss this opportunity completely by simply looking at the bottom line based on prepared financial statements, instead of analyzing every piece of the business individually and seeing how it relates to the given industry standards for normal expenses.
The management structure of your business is another issue to consider. Is your company multi-layered with a management structure in place or are there a limited number of people responsible for the business? Having limited management can be a great tool for enhancing the bottom line, but potential buyers are often looking for management succession and are not willing to rebuild the entire organizational chart.
Buyers may also try to discount your absence directly to the selling price of your business. Many times, a buyer will request that the owner work as a consultant to the company until they are fully acclimated. On the other hand, a multi-layered infrastructure can be a benefit to a seller because it can reconstruct the expenses and exclude most of the management costs, given that the new company will already fill these positions. A qualified adviser will be prepared to address these issues and negotiate what is most equitable for both seller and buyer.
Once a buyer is serious about pursuing the sale, he or she will provide you with a letter of intent and most likely proceed with the due diligence process, which involves taking an exhaustive look at your business’s financial records, sales figures, payroll reports, accounts receivables, etc.
The scrutiny of the due diligence process can be emotionally difficult for you as a seller. Having someone inquire about the way you run your business or criticizing it can have the same effect as someone coming into your home and criticizing your family. Unanswered or misinterpreted criticism can have a direct effect on the sale price of your business and can cause negotiations to fall through. Again, a professional adviser will be able to walk you through this process and help you to stay focused and objective.
The bottom line comes down to how the money changes hands. Some advisers recommend a 100% cash deal, while others prefer a blend of cash and future payments based on earnings, or an “earn-out”.
The idea behind an earn-out is that the seller will be paid a guaranteed minimum amount over a specified number of years, with the opportunity to receive a premium if the company exceeds sales and/or earnings expectations of the new buyer. You may want to accept a cash deal if you are uncomfortable with the expectations of future earnings. However, you may want to consider an earn-out strategy for tax purposes. A higher payoff may result in a much larger tax liability. By receiving smaller payments over future installments, your tax liability for the sale of the business will be spread out over a number of years.
Buyers may request seller financing, which allows them to utilize the extra cash for working capital until they are up and running. There are risks associated with this practice that you must consider. Accepting a note from another owner can be risky even if it comes with a personal guarantee and a blanket lien.
Many times the buyer’s current business assets already have liens, which will put you in a second or third position behind a bank or other financial institution. This exposure may not be worth it. Discuss all of your options with your advisor, who should be able to adequately qualify the buyer’s financial strength, management ability, and character. Remember that personal guarantees are only useful if the person guaranteeing it is solvent.
Bottom lines aside, you will likely care about who will take over the business you’ve grown from infancy. When you let go of your business, you want to be confident that you are putting it in good hands. Money is a key motivator in accepting a deal, but the character and strength of the new management team is also important.
Looking to the Future
Once you’ve sold your business, it is important to take steps to ensure that the profit you’ve realized can work to help you reach new goals. You may want to simply enjoy a newfound retirement or you may decide to sink your sale proceeds into launching a new business or career.
The task of executing proper asset allocation, estate planning, and tax planning will be important during this stage. Having key advisers during this transition will allow you to focus on getting your life in order while someone professionally manages your wealth to help you reap the fruits of your hard work for the rest of your life.
For more information, contact your relationship manager.