Every business owner will eventually leave their business. The question is, will they leave on their own terms or someone else’s? It is estimated that 70% of baby boomer-owned businesses are expected to change hands over the next 10 years (Robert Avery, Cornell University, February, 2006).
The majority of a business owner’s wealth is usually tied up in their illiquid business. For example, if you owned Apple stock, you could call your investment advisor and turn that stock into cash within 24 hours. With your privately held business, you can’t do that. You have to plan to make it happen. Did you know that the average business owner spends 80 hours developing a business plan – at a time when their business is worth very little – and spends 6 hours planning for their exit out of the business – when their business is presumably at its greatest value (John Leonetti, Exiting Your Business, Protecting Your Wealth, 2008)?
The lack of an exit strategy can result in a significant loss of this wealth. It is not a guarantee that a business owner will be able to leave their business when they want at the price they need. They need to plan for it to make it happen in order to meet their goals.
So why aren’t business owners stepping up to the plate and planning for their eventual transitions?
It’s called the “Ostrich Syndrome.” There are many reasons for not confronting the inevitable. If it’s a family-owned business, there may be questions about who will take over the business. If the first generation has doubts about the second generation, this can stall efforts to create an exit strategy. According to an ROCG Survey done in 2007, business owners claim planning for their exit is a daunting process. They say, “it’s too early,” or “it’s too complex, wouldn’t know where to begin,” or “it’s too time consuming.” The result? They become an ostrich, stick their head in the ground, and do nothing.
The logical thing to do would be to identify the competencies for the role, identify the gaps in the second generation, and create a plan to close the skills gap. However, too often these issues are handled in a more emotional manner. The first generation will often say, “It’s not time” or “I’m not ready to leave” rather than confront the issues head on. More complex family issues can also cause first generation business owners to stall plans for their exit.
Another reason business owners don’t confront leaving their business is fear. Fear of change, fear of loss, fear of the unknown. Much of a person’s identity can be wrapped up in what they do – in other words, who I am is what I do. So, if I leave and stop doing what I do, who am I? In reality, we are so much more than what we do. We have many roles in life. When one role stops, it makes room for another. The key is to find the roles that best suit the individual.
The business and the work itself have often provided the business owner with meaning and purpose in their life and a sense of fulfillment. It is important that a plan be made for replacing the business and the work with another role or activity that has meaning and purpose and is fulfilling or the loss will be deeply felt. A few examples include mentoring, volunteering, consulting, etc.
There are many risks associated with not planning in advance of your leaving the business. These include: not meeting your business, family and personal goals; selling your business for less than it’s worth; family in-fighting and discord; transitioning at the wrong time; and not having a successor developed (ROCG Survey 2007). Developing an exit strategy and exit plan can mitigate these risks significantly.
An exit strategy sets the context for the exit plan. A key element of the exit strategy is setting goals. Answering questions such as, what do you want this transition out of your business to do for your life? and what are your personal/family obligations? are essential to the exit plan.
As you can see, the focus of the exit plan is on the business owner rather than on the business. This is a departure from traditional business planning.
In addition to setting goals, the exit planning process includes determining financial readiness and mental readiness to leave the business and enter the next phase of life, identifying any gaps, determining business readiness, identifying exit options, determining the best exit option, and executing the option. Let’s take a look at each step in the process:
A few key points to consider….
- Would you want to transfer the business to family?
- Get the most money for the business?
- Diversify personally and keep working?
- Diversify and give back to your employees?
- Transfer the business to the management team?
To determine the business owner’s financial readiness, we calculate a personal balance sheet and cash flow projections. Next is to look at all assets, including the business value. We then determine how much annual income can be generated by these assets. This income plus cash flows from any other income flows is matched against projected outflows. If the income exceeds the outflows, the business owner is ready to move forward. If not, you have a “value gap.” When there is a value gap, we advise business owners to continue working in the business, work to increase its value, and increase other investments while still owning the business.
To determine the business owner’s mental readiness, we meet with the business owner and their spouse (or partner if applicable) to discuss and plan for such things as their thoughts/feelings about the transition, and to focus the business owner on what they are moving to, rather than on what they are leaving. We also work with them to create a plan for what they will do in the next phase of their life.
Is the business ready to be transferred or sold? Is the business owner operating his/her business as if it were for sale? We determine what the business owner needs to do to ready the business for sale.
There are two types of exit options available
Internal Transfers include: Family Buyout, Management Buyout, Employee Stock Ownership Plans (ESOP), and Gifting
External Transfers include: Sales to – a Synergistic Buyer, an Investment Buyer and to a Private Equity Recapitalization Buyer
Determining the Best Option:
The business owner makes the decision as to which exit option serves them best in conjunction with their exit planner. The decision is based on input gathered from the financial, business and mental readiness components.
Executing the Option:
Included in the exit plan is a timeline which delineates an ideal timeline for execution of the exit option. Of course, there are variables such as the economy, significant industry changes, family dynamics, etc., all of which can and will impact the timeline.