What is going to happen when you finally relinquish day-to-day control over your business? Are you going to sell it and live off the proceeds? Do you have a succession plan to ensure you can continue your legacy? Only you can know but, whatever you have in mind, it pays to have a formal and well thought-out succession plan and exit strategy.
Proper exit planning is necessary to avoid major risks. (To catch up on risk allocation in a purchase agreement essentials.) For a lot of owners, the transition of a business is a once-in-a-lifetime event. With the right plan, you can increase the business’ value and boost the proceeds you receive from transition, set up the successor for future growth and success, and help maintain employee harmony.
[Editor’s Note: Read up on Purchase Agreement Essentials and Risk Allocation.]
To emphasize: I don’t mean exit strategies are a good idea. I mean it is a really bad idea to not have one.
Without a formal plan, you risk walking away with much less than you could have. You may end up holding onto the business much longer than you had planned if the company isn’t marketed properly or streamlined for another owner. You might be forced to shut it down and walk away with nothing. You might even end up foisting the need to shut it down with nothing to show for the effort on your estate after you pass.
Most business owners say they are interested in having a formal exit plan, and most acknowledge how important it is. A few years back, PricewaterhouseCoopers (PwC) surveyed several hundred privately held businesses undergoing a transfer or sale. PwC found that approximately 80 percent of owners ranked “maximizing financial return” as the top succession objective, and “minimizing tax liability” was one of the top three concerns for 73 percent of those surveyed. It is very difficult to minimize your tax liability and maximize value of your business during the transition without the right plan in place. (Here’s a quick presentation on maximizing the tax efficiency of your assets.)
Despite this understanding, the 2016 U.S. Trust Insights on Wealth and Worth survey found that 63 percent of ultra-high net worth (UHNW) business owners “have not developed formal exit strategies.” Even more surprising, Millennial and Gen X segments were more likely to have exit strategies in place than Baby Boomers or older respondents. More than 60 percent of Millennial owners had an exit plan, compared with just 26 percent for Baby Boomers.
Seventy percent of business owners in the UHNW category reported using multiple financial advisers, and yet the majority still don’t have transition strategies. These information gaps should not exist.
PwC also revealed that approximately 66 percent of small to mid-sized business owners want to use the sale proceeds from their business to fund personal retirement or another venture. Yet we also know that 75 – 80 percent of business sales fail in any given year, and less than a quarter of business owners report having a formal exit strategy.
There’s also a demographic problem: Baby Boomers are trying to exit businesses at an increasing rate, while fewer and fewer members of younger generations are in the market to purchase an existing business. A report from the California Association of Business Brokers suggests that more than 12 million businesses will change hands over the next 10 to 15 years in the United States. In other words, there’s a building glut of business assets on the market.
You need to make sure you’re prepared to thrive in that market. This is especially true if your business is still small enough that your individual efforts (as the owner) comprise a significant portion of the business’ important workflow. In such cases, you aren’t selling an enterprise so much as selling a high-upside job opportunity. These kinds of sales require a lot of transition planning before a marketable business asset can be presented to prospective buyers.
[Editor’s Note: Please also check out our 2018 webinar Roadmap to Selling a Business or Taking on Outside Investors.]
You might not want to sell the entire business. You might pursue another kind of asset or termination transaction. (Asset transactions could include a sale of some portion of the business’s assets. Termination transactions can include an outright liquidation.) Alternatively, you may already have identified the next owner, whether an existing business partner, family member or employee.
If you don’t structure the transaction and transition properly you risk reducing the value of the business or jeopardizing the entire process. This is one of the major reasons why the answer to “when should I start exit planning” is probably “now.”
Consider your personal objectives. What do you want to accomplish down the road? Are those objectives best met through continued ownership or a successful transition? Should you consider training a successor or planning for divestment? What are you most concerned about?
Any planning you begin today will certainly pay dividends down the road and help you answer important questions. Perhaps most importantly, early planning will help you or the business cope with unexpected market or life events, such as a recession, death, disability, divorce or legal problems.
Things will go a lot easier if you have the right transaction team around you. Chances are rare that you’re already an expert in such transitions, so it’s best to approach this process with an integrated team of legal, tax, accounting and financial experts. (Check out our Working with Experts webinar.) It’s also crucial that you considered key employees and involved successor owners and your family in these decisions.
There aren’t any good reasons for ignoring succession planning and exit strategies. A well-prepared business owner can use this process to set up him or herself for a future of continued success and personal satisfaction. To learn more about this process, read Planning and Staging a Company for Transition.
Michele has been a director with Financial Poise since 2012.
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