Planning for an Exit
As a business owner, it is important to recognize that your business is not just where you work, but probably represents a significant portion of your net worth and your largest asset. The ability to monetize that asset is the most important financial event of your life. If you want to have a successful exit from your business which achieves your goals, it is important to establish and follow a strategic exit plan. A strategic exit plan is process oriented, not transaction oriented. Some owners may want to keep a business in their family; others may want to sell to outsiders – either way, formulating an exit plan years ahead of a transaction, and sticking to that plan, will help you as an owner ultimately realize your objectives.
The prospective buyer of your business will likely have bought several businesses. While you may be sophisticated in the art of negotiating terms in the ordinary course of your business, you probably have limited or no experience in selling a business. You should identify a team of experienced advisors to assist you with your strategic exit plan – ideally, a transactional attorney, estate planning attorney, accountant and investment banker. This team must understand your goals (financial and otherwise), have earned your trust and confidence, and be able to work well together.
Initially, you should ask yourself:
- How long until I would like to exit the business?
- How much money do I expect or need from the sale?
- To whom do I expect to sell the business?
Once you have answered these questions, determine what your business would need to look like in order to obtain the price you want from the potential buyer or group of buyers you have identified – and then build to that plan. Much like readying a home for sale, there will be investments which will increase the value of your asset while other investments will not be valued by your potential buyer and will not necessarily increase value. Focusing on your specific goals, and establishing a time frame to achieve them, will help you to realize a successful exit.
GROWING THE VALUE OF THE BUSINESS
If your long-term goal is a third party sale, it is important to look at your business through the eyes of the prospective buyer. A buyer will be looking to buy a business, not an entrepreneur. Accordingly, in order to maximize the value of your business asset, you must transition it from being led by an entrepreneur to being led by a management team. The business itself must have significant value apart from the entrepreneur. A well built team will (i) not result in a significant reduction in the value of the business if one member of the team leaves and (ii) allow the entrepreneur to focus on strategy and growth.
Most buyers will want to see demonstrated and sustainable earnings and earnings growth. Focus upon (i) what segments of the current market provide the most growth potential; (ii) where the best margins are in the business and how you can deliver more in that product area; and (iii) diversifying your customer base. A buyer will assign a greater value to your customer relationships which represent a recurring revenue stream if you have formalized them in carefully drafted contracts which can be assigned to a buyer.
In growing the value of your business, it is also the right time to be sure that you have the appropriate legal and financial systems and procedures in place. When potential buyers are valuing your business, they will want to review all records related to your business (the buyer’s “due diligence”). Not being prepared for the due diligence process can cost you as a seller millions of dollars in reduced value. Typically, a buyer and a seller will agree upon a purchase price before the buyer conducts detailed due diligence. Any issues which arise in the buyer’s diligence are opportunities to negotiate for a reduction to the agreed upon price. A careful review of all aspects of your business prior to initiating a sale process - from the financial statements, to the management team, to its agreements and commitments - will allow you to identify and implement solutions to resolve any issues which could impact the value of your business before the buyer commences its diligence.
You should also be prepared for a detailed financial review by the buyer. We recommend that clients have their financial statements audited for the three full fiscal years preceding a sale. Your business should have adequate systems in place so that your controller could be replaced without it being fatal to your business. If your financials are not audited statements, they still should be prepared in accordance with generally accepted accounting principles. Inadequate financial reporting and controls can lead to issues which can result in a purchase price reduction or a failure of the sale altogether.
Once you have grown the value of your business to the point where you are ready to market it for sale, be sure to involve your advisory team. The structure of the deal (asset vs. stock purchase; taxable vs. tax free) can have a significant impact on the after tax value to you as a seller. Other areas which can significantly reduce the value of the sale price to you include (i) the extent to which the buyer does or does not assume liabilities of the business, (ii) whether net operating losses can be preserved and used by the buyer, and (iii) whether any portion of the purchase price is contingent. If a portion of the purchase price is structured as an earn-out, you are more likely to realize the value of that earn out if you continue to have the authority and resources in the business, after the sale, to drive the results which will trigger your earn-out payments.
You should also consult with an investment banker or financial professional to assist you in evaluating proposed acquisition terms and understanding how they fit with your personal financial plans. The present value of your business, which may be less than you had hoped, may be more valuable to you than waiting out an economic downturn. A financial advisor can also assist you in analyzing the value of an all-cash offer as compared to an offer which has a portion of the purchase price payable on a later date, or subject to achieving certain milestones or satisfying certain contingencies.
Finally, in managing your sale process, keep the process short. If you have planned for the exit, you will not spend an undue amount of time assembling materials for buyer’s due diligence or having your financials prepared. From the time the parties agree upon price and general terms until the deal is completed, you are exposed to market and business conditions moving against you. It is also important to keep the sales process confidential. If the buyer attempts to change the proposed economic terms, or walks from the transaction for any reason, alternative buyers may see your business as dog-eared and not be willing to offer a competitive price.
The right strategic exit plan will allow you to receive maximum value for your business while minimizing risk and taxation. For further information, please contact Christopher G. Martin via email or at (203) 973-5220.
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