Business Exit Strategy

What Is a Business Exit Strategy?

A Business Exit Strategy is a plan for how a business owner can smoothly leave or liquidate their investment in their company, especially as they approach retirement or encounter unexpected personal circumstances. Instead of shutting down a successful business, the goal is to ensure a smooth transition for the owner, employees, and customers.

Any successful business plan should have a strategy in place on how the owner can leave the company at the end of their career. Very rarely do business owners create & run successful companies for the entire operation to be shut down. Instead, most companies are made to outlive their creator and thrive in business. 

Usually, the owner decides to retire from the company. They may have spent much time, energy, and capital on the company and want to retire comfortably. Having an exit strategy can help ensure that their business is in good hands when they are stepping down.

Another reason could be due to a sudden change in personal circumstances. If the owner becomes ill, defunct, or moves away suddenly, both they and their firm will have comfort in knowing that they have prepared for a situation where there was an unexpected turn of events.

Top Business Exit Strategies

The choice of an exit strategy depends on various factors, including the nature of the company and the market it's in.

If the owner's company is in a high-growth industry, they could cash out easily through a sale or IPO, but if relatives manage it, then the owner may pass it down to one of them. 

Regardless of the method the owner chooses to leave the company, they should prepare to put systems in place in advance so the business can operate without its original owner. This article will cover some business exit strategies and some of their benefits & drawbacks.

#1 - Sale of Business

A business owner may decide to sell their business altogether for a profit. This is a very common and popular way many owners exit their companies. 

This allows them to retire or move on to other business ventures through a quick and easy cash-out.

There are three major ways in which a company sale can occur. 

• It can occur as a private sale, where the company is sold directly to another business owner or investor.
• It can be merged with another company to create a whole new business entity where the company’s business processes are synergized.
• Or the company can be outright bought by another one and act as a subsidiary of the other.

Liquidation is also considered a sale of a business. Still, we will look at that in a separate section of the article, as it normally occurs when a company incurs more debt than it can handle or is no longer profitable.

This is usually considered a long-term capital gain and is taxed accordingly by the IRS. However, all business owners may not prefer this. 

It also results in a loss of revenue stream if the company is private and the owner has no more ties to the company, which may also be unfavorable.

We will go into more detail on the three methods of cashing out of your business for a profit through a company sale and look at the benefits and drawbacks.

#2 - Private Sale

The owner may choose to sell the confidential business to another individual or group if that group is ready to buy.

There are several steps an owner should take to ensure a successful transaction:

1. Valuation

You need to have value for your business, which can be done with the help of a valuation expert who can analyze financials, assets, & liabilities to determine worth & set a sale price.

2. Preparation

Now, the company needs to be prepared for sale. It includes improving the business through equipment upgrades & marketing efforts. You should also have a comprehensive package of financial statements, market materials, and all other relevant information.

3. Find Buyers

The owner may speak with other owners & competitors in the industry. Then, the owner works with a broker to negotiate a price & terms for sale.

4. Due Diligence

The buyer will spend a couple of weeks to months conducting their due diligence on the business to ensure all presented information is accurate. They will assess the size, complexity, and business model before deciding. 

5. Closing

Finally, the sale can be closed after the buyer's due diligence. It involves signing a purchase agreement and transferring ownership to the buyer, which could be a single payment, continuous payment, or an earn-out.

Benefits and Drawbacks of Private Sale 

Some of the benefits and drawbacks are as follows:

The Pros are:

1. Confidentiality: If your company relies heavily on company-customer loyalty, this is a way to keep the sale private. It can avoid feelings of uncertainty that may harm the business in public sales.
2. Flexibility: If the business has unique or specialized assets, this can give the seller more control over the terms of the sale, so they get the best deal for their situation.
3. Personalized Negotiations: The seller can negotiate directly with the buyer, creating personalized negotiations and greater control over the sale process.
4. Lower Transaction Costs: Fewer parties are involved, so there are lower transaction costs.

The Cons are:

1. Limited Buyer Pool: These sales can have a limited pool of buyers, making it more difficult to find a buyer.
2. Lack of Market Competition: There is less competition and, thus, no competitive bidding process, so the buyer faces less stress to pay a fair price for the seller’s business.
3. Increased Risk: Private Sales can be riskier than public ones, as the buyer may not perform the same level of due diligence or have the financial resources as a larger company, which means the company may struggle to survive after the sale.
4. Limited Exposure: Private sales may have less exposure for the business, which can be challenging for sellers trying to market the business and achieve the desired sale price. Ultimately, the decision to sell a business through a private sale will depend on the business circumstances and owner preferences. Therefore, it is essential to consider the potential pros & cons of each option & work with a trusted team of advisors to ensure a proper & successful transaction.

#3 - Merger

Another style of business sale is through a merger, where two or more companies combine their operations into one corporate entity. 

There are three ways a merger can occur:

1. Horizontal Merger

This merger occurs when two companies in the same industry & offer similar products/services merge, which increases the final entity company’s market share, reduces competition, and improves profitability via economies of scale.

2. Vertical Merger

Here, companies operating at different supply chain levels merge. For example, this could be a manufacturer merging with a retailer. It leads to greater control over the supply chain, const synergies, and more efficiency.

3. Conglomerate Merger

It occurs when two companies in completely different industries merge. And diversifies the revenue of the newly merged entity’s revenue stream and reduces the risk.

Mergers can occur in many different ways. Still, it normally occurs in a stock-for-stock exchange, where the owners of the selling company receive shares of stock in the merged company in exchange for their ownership stake in the selling company.

It also allows the owners to participate in the future success of the newly merged company. 

Pros and Cons of Merger

This method has many pros & cons and can be described as follows.

The pros are:

Combining operations can help the merged company increase market share & reduce competition.

1. Market Power: Combining operations can help the merged company increase market share & reduce competition.
2. Economies of Scale: Pooling resources can help the merged company achieve cost synergies & greater efficiency.
3. Diversification: Merging with another company in another industry or market can diversify revenue & reduce risk.
4. Access to new markets: Merging with a company with a strong presence in a new market or geographic region can help the merged company access new customers and growth opportunities.

On the other hand, the cons are:

1. Integration Challenges: Mergers can be complicated to execute. In addition, there could be challenges in integration, cultures & systems.
2. Costly: Mergers can be expensive, with legal fees, due diligence costs, and integration efforts.
3. Cultural Differences: Mergers can be companies with varying cultures, values, and ways of doing business together, leading to potential conflicts and challenges.
4. Regulatory concerns: Mergers may face government blocks that could stop them from merging.
5. Shareholder disagreement: Shareholders could disagree over deal terms and/or the direction of the combined company.

Mergers can be risky and complicated and involve many integrational challenges. Therefore, it is important that a company holistically examines the potential risks and benefits of a merger before proceeding with one.

#4 - Acquisition

An acquisition occurs when a larger company purchases a smaller company. This option is mutually beneficial, as the buyer can access new products, services, or markets while the seller cashes out. There are two types of acquisitions:

1. Strategic Acquisitions

They are made by companies looking to expand into new markets or gain access to products or services. These are motivated by synergies between the companies by offering complementary products or services or accessing new distribution channels. These are done to integrate the companies to realize long-term benefits rather than the target company's assets.

2. Financial Acquisitions

It is made by companies looking at a company for its assets or financial advantage. These can be motivated by acquiring valuable intellectual property or patents or gaining access to a larger customer base.  These are done to maximize short-term financial gains, such as selling off the acquired company’s assets or leveraging the customer base.

Regardless of the type of acquisition, the process involves several steps:

Step 1

Buyer conducts due diligence to evaluate the target company’s financials, operations & legal liabilities. They will also assess the benefits & risks of the acquisitions.

Step 2

After Due diligence, the buyer will negotiate the terms of the acquisition, including purchase price, payment structure, and any contingencies or warranties.

Step 3

Finally, the companies work together to integrate their operations and realize the benefits of the acquisition. It may involve restructuring or merging the acquired company with the buyer's existing operations.

Advantages and Disadvantages of Acquisitions 

Here are some of the pros & cons of an acquisition:

The Pros are:

1. Exit strategy: Selling the business through acquisition can provide the owner with an efficient and straightforward exit strategy.
2. High valuation: Acquisitions often result in a higher business valuation than would be possible through other exit strategies.
3. Synergies: The acquisition may result in synergies between the two businesses, improving profitability.

The Cons are:

1. Loss of control: The seller will lose control over the business and may need to give up critical decision-making authority.
2. Culture clash: The seller may not mesh well with the acquiring company's culture, leading to conflicts and difficulties in integrating the two businesses.
3. Legal liabilities: The buyer may inherit legal liabilities or other risks associated with the target company.

For the business to be attractive to the buyer, all the company financials must be in order, regardless of how the sale occurs. This option may also include working with a broker or investment banker to market the business, find the buyers, negotiate the terms & price, and plan any contingencies.

The owner would also work with tax experts to minimize tax liabilities & protect their interests.

#5 - Going Public

​​Business owners may consider exiting their company through an IPO or initial public offering. Through the NYSE and NASDAQ, their now-public company can have their shares bought and sold by investors.

It's easy for a quickly growing company to raise lots of capital in a single transaction by attracting many investors. A couple of prerequisite actions happen before a company goes public. A quick rundown of these steps is as follows:

Step 1

They work with an investment bank to create a prospectus, which provides information about the company’s business, financial performance, and management team. This gets filed with the SEC and made available to potential investors.

Step 2

The company & investment bank begin a roadshow, where they present their company to potential investors. Then, the company’s management team meets with the investors to discuss the company’s business & answer questions.

Step 3

The company sets a price for its shares based on demand. Then, they are sold to the public through an underwriter, usually the investment bank that helped make the prospectus. When the company goes public, the owner can sell off their shares to leave the business or decide to keep some and become a shareholder.

Benefits & Drawbacks of Going Public 

While this may seem like an excellent way to alleviate yourself from the effort of running the company and take the role of a shareholder, this method does have some benefits & drawbacks. 

The pros are:

1. Access to Capital: An IPO can provide a significant influx of capital to the company, which can be used to fund growth initiatives, repay debt, or make strategic acquisitions.
2. Increased visibility and credibility: Going public can bring more attention to the company, attracting customers, partners, and employees.
3. Liquidity for shareholders: Going public will give the shareholders a chance to realize a return on their investment in the company.
4. Ability to use stock as currency: Publicly traded stock can be used as currency for future acquisitions or mergers, which can help the company grow more quickly.
5. Potential for higher valuations: Public companies are valued higher than private ones, which can increase shareholder returns.

The cons are:

1. Cost and complexity: An IPO can be a complex and expensive process, requiring significant time and resources from the company's management team and advisors.
2. Increased regulatory scrutiny: Public companies are subject to strict reporting and disclosure requirements.
3. Loss of control: The founders & management team of the company will have less control over operations and strategic direction.
4. Pressure to meet expectations: Public companies must meet quarterly earnings expectations and provide regular updates to investors, which can be challenging and time-consuming.

Public firm shares are easily affected by ups and downs in the stock market. It can change stock prices to factors the company can't control, like economic changes, industry trends, and investor sentiment.

An initial public offering can quickly raise capital and exposure for growing companies. Still, it would be best to consider all the pros and cons of IPO as your business exit strategy.

#6 - Family-Owned

Another option includes passing the business down to family members. Many business owners try to do this, passing it as a gift or through a sale.

Several important tax implications must be considered if an owner decides to pass the business as a gift. The owner will need to file a gift tax return, so they need a valuation for the business. They also want to minimize this by using the annual gift tax or lifetime exclusion.

The owner could also sell the business at a fair market value through a:

• Stock purchase
• Traditional buy-sell agreement
• Family member

When passing the business on, it is important to consider that the family member taking it over has the skills & experience necessary to run the business successfully.  You may consider providing training or mentorship to the member or hiring a third-party consultant to help with the transaction.

Also, consider the impact this will have on family members not involved in the business, as there may be concerns regarding fairness & equal treatment that may disrupt family relationships. 

Pros and Cons of Family-Owned

Some pros and cons to consider when using this strategy are explained below.

The Pros are: 

1. Continuity: One of the biggest advantages of passing the business on to family members is its continuity, which can help maintain the company's culture, values, and traditions.
2. Smooth transition: Passing the business on to family members can also provide a smoother transition than selling to an outside party. Relatives may already be familiar with the business operations & customers, which can minimize disruptions from management change.
3. Financial benefits: Depending on the circumstances, passing the business on to family members may also provide financial benefits. For example, if the business owner passes the business at a reduced price or as a gift, it can reduce the tax implications of the transfer.
4. Personal satisfaction: It can be rewarding to see the business continue to grow and thrive under the leadership of a family member, making passing the business to a family member can be personally satisfying and fulfilling.

The Cons are:

1. Family dynamics: One of the biggest challenges of passing the business on to family members is the potential impact on family dynamics. This can include issues related to fairness, jealousy, and resentment among family members who are not involved in the business.
2. Lack of experience: The owner needs to ensure the relative who takes over the business has the right qualifications & skills to run the business and minimize the chance of them putting the company's future at risk.
3. Limited market: Another potential downside of passing the business on to family members is the limited market for the company. Relatives may not have the financial resources to take over the business and may limit the owner's options.
4. Business performance: The transition to a family member may impact the performance of the business. If the family member is less effective a leader than the previous owner, it can lead to decreased profits and reduced success for the company. It is a great way to keep a business under family leadership and ensure the company lives on for future generations. Still, handling it fairly, transparently, and successfully requires lots of planning.

#7 - Liquidation

What if the business at the time of the owner's exit is not profitable or capable of earning revenue?

It may result in company liquidation. The management sells all assets for cash to pay off creditors and outstanding debts, which includes inventory, equipment, & property. The proceeds of the sale of assets are distributed to creditors and shareholders according to a predetermined order of priority.

First, the assets and liabilities of the company need to be assessed. After they receive an appraisal value, a plan is made to sell them off via auctions, private sales, & negotiations with potential buyers.

After all the proceeds have been collected, the remaining debt is paid off in a predetermined order. This includes secured creditors, like banks and other lenders, then unsecured creditors, like suppliers and vendors. Finally, anything left is distributed to shareholders.

Advantages and Disadvantages of Liquidation

A liquidation is a good option for businesses that are not profitable or have too much debt to equity. However, stakeholders may prefer something other than this option as they get little to no return on their investments while employees lose their jobs. Other pros and cons include:

The Pros are:

1. Simplicity: Liquidating is pretty straightforward, as you sell your assets to pay your liabilities. This is an easy and fast way to exit the business if you have few assets and creditors.
2. Control: By liquidating the business, the owner retains control over the process and can determine the order in which debts are paid off.
3. Relief: Liquidation can provide relief for business owners struggling with financial difficulties, simply wanting to retire, or wanting closure so they can pursue other ventures.

The Cons are:

1. Limited Return: In many cases, liquidation results in little or no return for shareholders, which can be frustrating for owners who invested significant time & capital into the business.
2. Employee Displacement: Liquidation often results in the business closing, which means employees lose their jobs. 
3. Legal Costs: Liquidation can be a complex legal process that requires the expertise of attorneys and other professionals and can be costly for an already struggling business or if a business has lots of assets.
4. Reputation Damage: The liquidation process can also damage the business's reputation, particularly if seen as a failure or a sign of financial instability. This can shake the confidence of investors in the owner's future ventures. Liquidation is a viable exit strategy for some businesses, but weighing the potential outcomes with financial and legal advisors before pursuing this option is important.

#8: Management Buyout

A management buyer (MBO) is an exit strategy where the current management team purchases the business from the owner.

MBO can help a business owner sell their company to someone they trust (or a group of people). It also gives them the satisfaction of knowing the company is in capable hands. In an MBO, the management team borrows funds from a bank or other lender to finance the purchase of the business from the owner. 

There are many pros and cons to this method:

The Pros are

1. Business Familiarity: The managing team is familiar with the business operations, which can reduce the risk of disruptions.
2. The incentive to Grow the Business: The management team may have a stronger incentive to grow the business after taking ownership since they will now be owners. And can motivate them to be focused on driving the business forward.
3. Confidentiality: An MBO can be a good option for owners who want to maintain confidentiality during the sale process since the management team is already familiar with the business and can keep the sale private.

The Cons are

1. Risk of Financial Strain: The management team may lack the financial resources or expertise to run the business successfully. This could cause a drop in valuation for the business if it cannot leverage the financing method of choice.
2. Limited Market: The pool of potential buyers is smaller in an MBO, limiting the price the owner can receive for the business.
3. Potential for Conflict: The management team may struggle to agree on the purchase terms or work together effectively after taking ownership of the business, which can lead to conflict.
4. Complexity and Time-Consuming: An MBO can be complex and time-consuming. The management team must secure financing, negotiate terms with the owner, and manage the transition process. An MBO is a solid option for business owners to sell their business to trustworthy people who know how to run it. However, it is essential to consider the risks and benefits of an MBO carefully and to work with experienced advisors to navigate the sale process.

Summary

A business exit strategy outlines how the business owner will exit at the end of their career.

There are several common business exit strategies, including

• Selling to a strategic or financial buyer
• Transferring ownership to family members or employees
• Going public
• Liquidating the business

Every strategy comes with its own set of benefits and drawbacks, which can impact the exit timeline & financial goals of the owner and the health & value of the company.

Ideally, the business owner should plan their exit 3-5 years in advance to ensure they maximize the business and have a smooth transition. To make their exit strategy they should consider advice from:

• Business brokers
• Financial planners
• Accountants
• Tax specialists
• Family
• Attorneys 

They will guide various aspects of exiting the company, help fairly value the business, negotiate terms, and manage the implications of tax when the exit occurs.

Ultimately, a well-planned exit strategy can help business owners achieve their financial goals, have a smooth ownership transition, minimize risk & uncertainty, and secure a future long past the original owner's life.

Researched and Authored by Rohan Rajesh | Linkedin

Reviewed and Edited by Justin Prager-Shulga | LinkedIn

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