Why is it that many successful entrepreneurs fail to adequately plan for what is likely the largest single value transition in their life, the exit from their business?
The consequences of failing to adequately plan for this important event can be devastating. Without a plan and proper execution, business owners may suffer the consequences of a loss of considerable value. The transfer of ownership of their business may be forced to occur when the business is least prepared for such an event. In many instances the continued success and longevity of the business is put at considerable risk—just the opposite of what most business owners expect or desire to have happen after working many years at building a successful business.
What exit scenarios are possible? It is a relatively short list when you think about it:
- You can liquidate the business assets and close the doors.
- You can transition the business to family members and/or key employees.
- You can sell the business to an unrelated third party.
Let’s explore each alternative in detail.
1) Liquidation involves the sale of the tangible assets of the business. This is usually the least desirable of the alternatives. Why? Because the business owner will not benefit financially from the intangible value of their business upon liquidation, the value attributable to the profit-making potential they have worked so hard to create, usually over many years. And following the sale of the assets, the doors are closed. This is not what the business owner envisions either. As you can see, liquidation is usually a last resort and not a viable option for profitable businesses with owners desiring to maximize value.
2) What about a transition of ownership to family members or perhaps key employees? This is a viable option that many entrepreneurs consider but it must be done only after careful analysis and planning. Does the next generation possess the requisite skills to truly manage the business to long-term success? Or is this just wishful thinking on the part of the business owner? This can be an emotional situation wrought with pitfalls that have the potential of wrecking havoc on family relationships. Some business owners consider an ESOP as a vehicle for this transition, but these can be complicated and costly.
Careful planning is essential in positioning a family transition for success. Second- and third-generation businesses can be found but are rare indeed, and usually indicate the entrepreneur developed a well-thought-out plan. What are the key elements of such a plan?
The first question that many business owners take for granted is whether the next generation really has the desire to take over for Mom or Dad. We are finding on a regular basis that many of the current generation lack the desire to be the boss. They are perfectly content with assuming a responsible position in the company, but they have no desire to put in the extra time and make the commitment that Mom or Dad did.
If they have the desire, do they have the skills? Are their skills well-rounded and developed? Can they step in and be successful? After all, many will tell you that business is much more complicated today. Many entrepreneurs would be well served to seek independent assistance with this issue. A solid transition plan addresses the shortcomings of the next generation and commits to the development of the missing skills or acknowledges that these skills must be obtained outside of the family structure to ensure the ongoing success of the business.
If a transition to family and/or key employees is the right answer, how does the business owner recognize the value of their business? Significant disagreements can ultimately emerge if the transition plan does not address the means of determining the true value of the business and how this value will be recognized by the owner. Fair and objective value propositions for family transitions usually include some or all of the key attributes seen in third-party transactions. An independent assessment of value is a good starting point. And key deal terms that result in an appropriate recognition of value by the owner but leave the next generation confident they can be successful must be explored.
3) When qualified family or key employees do not exist, or are not interested, the business owner is left with the difficult task of selling to an unrelated third party. Properly done, and with appropriate and timely planning, this can be the most effective means for the business owner to recognize the true value of their efforts and ensure ongoing success for the business.
A successful exit through a sale to a third party is usually accomplished by developing a well-thought-out plan. The timing of the development of the plan is critical for many reasons. Business owners must realize they are not in control of external market factors. And it is these factors that have much to do with the value of their business.
The merger and acquisition market was very successful in the mid-2000s and even well into 2008. Business values measured by multiples of cash flow reached all-time highs. Private equity was abundant, and lenders were ready and willing to leverage transactions with large amounts of debt. How quickly things changed. Credit markets evaporated and the merger and acquisition market came to a halt. Most industries experienced a downturn. So not only did profit and cash flow deteriorate, but the multiples that buyers were willing to pay went down as well.
A sound strategy enables business owners to be in control of the timing of their exit. Successful exit strategies identify the businesses’ weaknesses and create plans of corrective action that owners can implement over a timeline of their choosing. Action plans can include diversification of the customer base, the expansion of product or service offerings and the shoring up of a weakness in the management team, amongst many other things. The end goal is to improve financial results and enhance business value.
While exit alternatives are limited, entrepreneurs are well-advised to evaluate their alternatives and commit to the development of a sound exit strategy several years before their anticipated exit. This will enable them to enhance the value of their business and take advantage of favorable market conditions. The bottom line—entrepreneurs are rewarded for many years of hard work.
Do you have an exit strategy? iBi
Stan Lynall is the founder of LMA Consulting, LLC, which provides specialized financial consulting services to businesses in central Illinois and the Midwest.