Understanding a business exit strategy
A business exit strategy determines what will happen to you and your business when you decide it’s time to leave. Ideally, an exit strategy and a business plan should be drafted simultaneously.
After all, the manner in which a business is concluded, is as important as the reason for starting it in the first place.
An exit plan may include the end of the business or a transition to a new phase. It may provide for the business owner or founder of a startup to stay on in a different capacity or leave altogether. In fact, many ambitious entrepreneurs start their ventures with the express intention to exit it eventually via an initial public offering (IPO). This exit strategy usually results in a very committed founding team that works hard to scale their business as fast as possible.
If a business is doing well, an exit strategy will bring about maximum profits for the business owner. If the undertaking is struggling, an exit strategy can limit losses.
Why it’s important to have an exit strategy
Established companies, small businesses, and new startup ventures need an exit strategy of some kind. Whether it’s an acquisition, transfer of ownership, or an IPO, it’s best to plan for something that you know is bound to happen at some point, because your judgment may be clouded by emotions when the time comes.
The best way to grasp the importance of exit planning is to look at the benefits it provides.
Benefits of a business exit strategy
It will guide your company’s future
An exit strategy can act as a guide for your company’s future, its goals, and how it will be run. It can work in tandem with your business strategy to keep you on target regarding your goals and to allocate resources accordingly.
Whether you are building a family business or a tech company that you eventually want to sell, your exit strategy will determine the course of your company.
Whatever you decide to do eventually, the fundamental issue is to at least understand the value of your business. Knowing the value of your venture may alter your exit strategy.
If you want your business to eventually provide for your retirement, you have to determine its worth. If you want investors to acquire your undertaking, you also need to know what it is worth, so you can secure a fair price for it.
Once you have gone through the exercise, you will be able to see whether your business is on track to realize the financial goals set out in your business plan and exit strategy.
Unsolicited offers won’t catch you off guard
Unsolicited offers are not uncommon. According to research, nearly a third of business owners receive an unsolicited offer to buy their business. Most business owners don’t know how to respond to such unexpected offers except to feel flattered as a business person and excited about the possible financial implications. In reality, the offer might not pan out to provide financial security or other benefits for the owner.
An exit plan helps business owners to respond to unsolicited offers. While an unsolicited offer may appear enticing, you can only know if it’s really lucrative if you have established the value of your enterprise and what it will take for you to achieve financial independence.
Your business becomes attractive to investors
An exit strategy makes a business more attractive to investors. An exit strategy demonstrates that the business owner has a long-term vision for the business and has put processes and actions in place to achieve those goals.
For instance, if a startup develops a tech solution with the express aim to eventually sell it, this intention will be clear to investors. The startup will be ready with a specific value offer for investors attracted by a goal-oriented business venture, estimating it to be a solid investment. There are many different types of investors, such as angel investors or venture capital firms, make sure you understand the difference between them all. You can learn more about how venture capital works on this other blog.
It will help you mentally prepare for negotiations
Having a business exit strategy in place prepares you for the negotiations at the time of exit. If you intended to sell, you’ll know the true worth of your venture and you’ll be prepared to negotiate a fair deal.
Whether you intended to leave the company to a family member, accept a buyout by a partner, settle for liquidation, or accept a buyout by employees, with an exit strategy, you’ll at least be mentally prepared for what may prove to be an emotionally draining time.
With an exit strategy and knowledge of your venture’s value, you are in a good position to negotiate for a fair outcome.
Factors to take into consideration
When planning a business exit strategy, answering the following questions may help to guide your thoughts:
- What are your financial goals? How much do you want when you leave the company?
- Do you want to stay involved with the business, but have fewer responsibilities?
- Will your business continue or end when you leave?
- How long will your exit take?
- What will happen to the business assets?
- Does the business owe money to any investors or creditors? How will that be taken care of?
Note: plan to regularly re-evaluate your exit strategy to see if you need to make any adjustments as circumstances tend to change, especially in these uncertain times.
Seven possible business exit strategies
1. The family succession exit
Also called the legacy exit, this strategy keeps the business in the family. Leaving your business to a family member like a child or another family member has the advantage that the person will already be emotionally and mentally invested in the business, with probably intimate knowledge of it.
This may seem like an obvious route to take, but it’s crucial to judge the person objectively to be sure that he or she has the skills and interest to take on the leadership of the business.
Also, family relationships are notoriously complicated. The business owner must make sure that the general family relationships can withstand the added stress of business relationships. Keep in mind that while this may be ideal for your business from your perspective, there might not be a suitable person to take over the reins when the time comes.
2. Acquisition by another company
With an acquisition, a competitor or similar business acquires your firm. If the other company acquires more than 50% of your company, you give up control of your company. If not, you will be able to negotiate the terms of your new position, which should be done with great care as the new entity will have different dynamics that might be challenging to adjust to. Be sure to enlist the services of an attorney to help with the acquisition agreement. Acquisitions tend to be time-consuming, and they often fail – according to Harvard Business School, they fail most of the time, with a failure rate of 70 – 90%.
Media reports create the impression that acquisitions only happen among large, prominent companies, but acquisitions and mergers are also common among small- to medium-sized businesses.
3. Merger with another company
A merger is an agreement between two companies to become one entity. Mergers usually happen between two companies that are a similar size in terms of numbers of customers, and the scale of operations. The two companies agree to become a new entity because they believe that, as one, they can achieve more success. The main benefit of a merger is that it increases a company’s value.
A merger offers business owners the opportunity to stay on in the new business in some leading capacity, but you could also end up severing your ties with the business altogether. Like acquisitions, mergers are fairly common between companies of all sizes.
4. Sell the business to someone you know
A business owner can choose to sell to a private buyer such as a key employee, family member, business partner, or co-founder. Here the main benefit is selling to someone you know and trust. There are different reasons for selling to the various people in your circle.
Selling to a family member will keep the business in the family, selling to a partner or co-founder means the business will continue as before with someone who is also committed to its success, and selling to a key employee who has already contributed to the firm’s success ensures a favorable future outcome.
The only drawback of this exit strategy is the possibility that the business transaction may be influenced by the existing friendly relationship, resulting in a less than profitable agreement for the business owner.
5. Management or employee buyout
In this scenario, instead of selling to an individual in your company, you sell your business to people who are already working in the company. In a management buyout, your management team purchases the assets and operations of your business. In an employee buyout, your employees buy a majority stake in your firm.
These are two viable exit strategies as these people already know the business and how it’s run. In the case of a management buyout, these individuals are already involved in the management of the business. This business exit strategy could be the least disruptive to operations and could increase loyalty and morale among the workforce.
With this business exit strategy, you may or may not be able to negotiate a future position in the company. One drawback is that such a move will change the dynamics in the company, with some key people and others deciding to leave. Depending on how the change is communicated to customers and how it affects your service to them, this strategy may also alienate some customers.
6. Liquidate Your Business
Liquidation is the process of closing a business and selling off all business assets. This is not necessarily an exit chosen by the owner. Rather, it’s an option brought about by various and ,often, adverse circumstances. Liquidation usually occurs when a company is insolvent, meaning it cannot meet its financial responsibilities.
The only money to be made is by selling assets like real estate, equipment, office furniture, inventory, and the like. And this money must, first and foremost, go to shareholders and creditors.
This is often a last resort option as this decision has far-reaching consequences for employees and loyal customers who have come to depend on what the firm has to offer.
While this can be a relatively quick process, liquidation of a company is not something that a business owner can attempt without legal assistance as there are many prescriptive procedures to adhere to.
7. Initial public offering (IPO)
An initial public offering (IPO) lets you sell part of your company as stock to be traded on a public stock exchange. This opens up the opportunity for large numbers of investors to buy shares in the company. These investors can be private citizens or institutions.
When a private company goes public, there is no more private ownership in the company. A CEO and executive committee now become answerable to a board of directors and shareholders. In return for giving up ownership, the company receives an enormous cash injection from the millions of investors who bought shares in it.
An IPO provides the company with access to millions of dollars, which it can use to grow and expand. The original team stays intact, but is now answerable to shareholders and a board of directors.
An IPO is often the express exit strategy of a company’s founders and early investors, who hope to gain a significant return on their investment. However, an IPO is not an exit strategy for most businesses. Companies only qualify for an IPO once they have reached a certain value or can show strong fundamentals and above-average profitability potential.
An IPO is not an easy exit strategy. Publicly traded companies face extra scrutiny from financial authorities, and the process itself is extremely demanding and time-consuming, involving high regulatory costs out of the reach of the vast majority of privately owned businesses.