When you set up a business via a company formations agent, the last thing you’re thinking about is an exit strategy. That’s a mistake. Every entrepreneur or small business owner must have an exit strategy even if their business is still in its infancy.
You may ask why it’s necessary to plan an exit strategy so soon after company registration. There are various reasons, but the most important ones are:
- The majority of entrepreneurs love the thrill of setting up a new business and seeing it off to a successful start. However, they don’t want to stick around focusing on one business for life. If you’re aware of this and think about possible exit strategies from the beginning, it’s so much easier to move on to the next exciting business idea.
- Your investors (if you’re not the only one) want to see a return. This can only happen if they cash out or the company is sold.
- You want to see the back of the business because it’s not as profitable or exciting as you thought it would be.
An exit strategy isn’t something negative. On the contrary, it should be focused around optimizing a favourable situation. Don’t wait for a negative situation to force you to think about an exit strategy. Think of it as orchestrating a successful transition or bringing to life a succession plan.
Here are 5 possible exit strategies for small business owners to consider:
- Friendly buy-out
Selling to a family member or employee may be one of the easiest exit strategies if your business is lined up for this. Employees who know they have the option to buy you out eventually will work harder to make a success of the business. The future of the business is also more secure because the new owners know it inside out and can simply continue as before if they want to.
Selling to one or more employees can be done in two ways – a straight purchase or an Employee Share Ownership Plan (ESOP). The latter is a stock equity plan that lets employees acquire ownership in a company.
The other possibility concerning a friendly buy-out is to sell to a family member. For example, you may have started the business for your children to take over.
Selling to a family member or employee certainly has its advantages. You’re dealing with familiar faces who you know have the interest of the business at heart.
However, don’t be blind to the possible pitfalls in such a scenario. A sale remains a sale, no matter who the buyer is. Be careful not to lose objectivity and not to let your guard down during negotiations. Even if it feels unnecessary, it’s best to hire a professional to assist with the sale through a transfer of business ownership agreement.
- Acquisition or merger
A merger involves the merging of your business with a similar company, while an acquisition simply means your business is bought by a larger company.
There are different reasons why another company may be interested in buying your business. The main ones are:
- A new acquisition is a quick path to expansion.
- The two companies have complementary skills and combining results in the saving of resources.
- You are competition in which case they may shut the business down after purchase if the only purpose is to get rid of competition.
A key factor if you plan on an acquisition or merger as your exit strategy, is to make your business as attractive as possible for potential buyers. It’s not always that easy to sell a small business, especially on the open market. Or there is interest but at far lower prices than what you were expecting.
A competing business may be easier to sell too. It’s a good idea to identify a potential buyer or buyers in advance and groom your business for sale accordingly. This includes having all systems in place and information at hand to convince them your business is worth the asking price.
- Liquidation and shut down
I don’t know about you, but for a long time I associated the word liquidation with failure. It’s not. Shutting down and liquidating your business can be an effective exit strategy especially for a very small business that depends on a single individual. Sometimes there isn’t much to sell, so liquidation is the only option.
The one big advantage of liquidating and shutting down a business is that the process is relatively simple. It involves an asset sale if there are assets to get rid of and that’s it. In some instances, it may include the selling of the business name for someone else to use however they like. The name of a business that has been around for a very long time can be worth buying.
A liquidation sale can also be the biggest disadvantage of this kind of exit strategy. Here’s why:
- The only money you’ll put in your pocket is that from the disposal of assets. Your client list and other intangible assets are basically worth nothing.
- It may be hard to sell second-hand equipment at worthwhile prices.
- If you have creditors, they have the first claim on the money raised through asset sales.
Note: Liquidation is not the best option for companies with a loyal customer base and employees depending on its continued existence. In this case, selling the business is a better exit strategy.
- Initial public offering
An initial public offering (IPO) is the first sale of stock issued to the public by a company. While not applicable to most small business, it can be very profitable if you fall in the minority. In fact, this used to be the preferred exit strategy to get rich quick.
The reasons why IPOs are becoming rarer despite the press they usually get are multiple. They include:
- The IPO process is lengthy and costly. It could require an upfront investment of tens of thousands of dollars.
- An IPO is labour intensive and requires high standards of reporting and compliance. Public companies must produce detailed financial, operations, staff, management, and marketing reports.
- You may not be allowed to withdraw your capital at the time of the IPO. The reason is that it may be required by shareholders for the expansion of the business.
- Shareholders can be demanding!
- Draining it (or liquidation over time)
This exit strategy is to be considered where a business generates a lot of cash flow without the owner’s constant attention. He or she withdraws all or most of the profit over time, either in the form of a large salary or dividends.
Basically, the business serves as a cash cow until the owner decides to sell or liquidate it. Such companies are also called “lifestyle companies”. However, this strategy doesn’t come without disadvantages. They could include:
- Taking the money out in the form of a salary may result in a huge tax bite. At the same time, keeping the profit in the business to raise its value and get a higher sale price means you will have to pay capital gains tax.
- If you’re not the only shareholder in the company, then others may object to you extracting profits and demand similar payments.
- Withdrawing profits reduces growth potential which impacts on the sale value of the business if that remains part of your exit strategy.
Which exit strategy is best for your business?
Every entrepreneur or small businessman should choose an exit strategy based on their personal goals combined with the type of business.
Draining a business by using it as a cash cow may be suitable for the owners of nightclubs, consulting firms, and restaurants. If you’re planning on making a huge profit before walking away, an acquisition or merger is the best strategy. But if you want to see your legacy live on and the business continue without you, selling to a family member or employee may be a better option.
Here are some questions to consider when choosing an exit strategy:
- What are the exit options for your particular startup or small business?
- Why did you start the business in the first place?
- What is your long-term goal for the business and how do you see your future role?
- What are your liquidity needs?
The most important thing is not to wait until you are in trouble to think about an exit strategy. This will allow you to optimize a good situation rather than having to take what you get in a bad one. By having an exit strategy in mind during the planning stage of your business, you can manage your business and focus your efforts on what will make it more attractive for whomever you intend to take over from you.