Creating an exit plan should be a part of your business practice, regardless of what stage of growth your company is in or what type of economic environment exists. Having an exit plan simply means that you have analyzed the possibilities for the ultimate sale or transfer of your business's ownership and control. This plan includes an understanding of the tax and business implications of each option and takes into account the wants and needs of your company's future owner. Understanding your eventual exit, even if it is years off, will allow you to align day to day operations and decision making with these goals.
Let's start with a few illustrations on how an exit plan affects day to day operations. A business owner who plans to sell to an outside buyer will want to record the highest level of profits, and consistency in those profits, the years prior to sale. Alternatively, an owner who wants to transfer to a management team, or perhaps install an Employee Stock Ownership Plan (ESOP), may decide to include key managers in both strategic and tactical planning today so that they are empowered with more authority and decision making in the business. These types of forward thinking decisions may be the difference between the success and failure of your exit and whether or not you ultimately protect the wealth in your business. These examples show the importance of aligning your company's resources with your exit plan. So how do you determine which is the optimal path for your company? We offer three steps that pull this planning together.
First Step: Assessing Ownership's Readiness
The first step in creating an exit plan is to determine your overall goals as well as how prepared you are for an exit. After figuring out how you would like to live 'beyond' the business, you will need to accurately assess how much money is required to maintain that lifestyle. This process includes an analysis of your dependency on the business not only for income, but for benefits such as car payments, health insurance, and other lifestyle expenses. Determining what you need versus what you currently have saved outside of the business will help you choose an exit option that can bridge that financial gap.
In addition, you will need to assess when and how you want to exit. Exiting a business that has been built by years of hard work and dedication can be a difficult emotional hurdle, often times impacting employees, family members, and, perhaps, your community. How involved are you in the day to day operations of the business? What will you do with your time when you are no longer running the business? Do you view the business as a 'job' or as an 'investment'? These answers will become vital when you start looking at the company's exit options, trying to find the one that best meets your goals.
Second Step: Know Your Exit Options
Selling the business -- Most owners understand that they can, generally speaking, get the highest value from their exit by selling to someone in their business (or a related business). The downside, for most owners, is walking away from a company that took years of hard work and dedication to build. This option is best suited for owners who are truly ready to leave and are not overly concerned about giving up control of the business.
Private equity group recapitalization/financial partner -- A subset of 'selling' is bringing in a financial partner. This option allows an owner to retain operational control through an employment agreement, while selling strategic and financial control. The upside to this transaction is that you can continue to work in your business, receiving income and participate in the future value of the business when it is later resold (generally, you will retain a minority stake in the business). The downside is that you become an 'employee' of your new owner -- a tough pill to swallow for many business owners.
Employee Stock Ownership Plans (ESOPs) -- ESOPs are a powerful tool for the business owner who is not ready to give up control, but would like some diversification and liquidity today. ESOP are flexible in the sense that they can be customized, combined with other options, and/or implemented over several years to meet an individual's needs. The ESOP's complexity can be overcome with an open-mind from the business owner and an experienced professional who can assist in seeing whether this exit option is applicable to their situation and need.
Management buyouts -- This is an excellent option for business owners who have saved for their financial future and want to pass the business to their management team. The success of this option is highly dependent on the circumstances of the individual business and of the people involved. Generally speaking, these types of transfers take years to implement correctly.
Gifting programs -- Some business owners are not interested in extracting value from their companies. Instead, they wish to give their businesses to family, employees, or charities. The important consideration here is how to incorporate gifting while limiting tax liabilities. Gifting programs are mostly tied to larger estate planning tactics as well.
Each exit option offers benefits as well as consequences and some may be better suited to your exit plans than others. It is important that you understand the pros and cons of each option and how they will separately help you reach your personal goals.
Third Step: Executing Your Plan
You should seek the counsel of experienced advisors when it comes time to execute your exit plan. From tax issues, to legal agreements, to negotiations and projections of future cash flows, it is important to align your advisory team with the objectives that you have stated in your plan.
Creating an exit plan will give your company a safety net of knowing the best exit option for you and the company. This direction will help align your day to day operations and strategic decisions, so that your company is better prepared to reach its long-term goals and for you to reach your personal objectives with your exit.
John M. Leonetti, Esq., CFP, CM&AA, is the founder and managing director of Pinnacle Equity Solutions, an exit strategy planning firm that offers planning services to business owners as well as education and training programs for professional advisors. He is the author of the book, Exiting Your Business, Protecting Your Wealth (Wiley/October 2008). For more information, visit www.exitingyourbusiness.com.