Exit Strategy: Transitioning Your Business to a New Owner

January 4, 2020 | Article

While each business owner chases success in his or her own unique way, there are some things nearly all owners have in common. Hard work, determination, a vision of what could be, and the will to make it happen—these are the stock and trade of anyone who starts a business.

There’s also another common factor that binds together all business owners: The need to someday transition your business to its next owner.

For some, the decision will come early in the life of their business, and they will be on to the next big thing. For others, it may be among the last decisions they make as an owner. Regardless of how you reach this milestone—whether it’s retirement or a buyer knocking at the door—an understanding of the transition process will go a long way to making this event smooth and amicable.

Exit strategy has many moving parts. Check out our guide to help you set strategy and direction early.

Why do I need to start planning for exit early?
One of the first questions you’ll ask when you transition your business is who your potential buyers are, and it may not be as easy as you think.

It happens all the time. Mr. Doe starts a widget business and pours his heart and soul into it. After years of developing relationships, assembling a workforce, creating a brand and achieving success, he’s ready to transition to retirement. In fact, he wants to move to Florida in the next six months. Mr. Doe consults a transaction advisor, who has a fairly standard list of questions to learn more about Mr. Doe and his situation.

“Do you have any family members interested in the business?” the transaction advisor asks.

“No,” Mr. Doe says.

“Do you have any key employees who have the interest or skill set to buy and run the business?”

Mr. Doe shrugs. “I have had some over the years, but they have moved on to other opportunities.”

“Do you have good management depth?”

“Not really, everything runs through me,”

Mr. Doe says. “I call all the shots.”

The transaction advisor looks thoughtfully at Mr. Doe and leans forward. “Do you think we can find a buyer to invest in this business if you aren’t a part of it anymore? If you own all the customer relationships, know-how, technical expertise, and the brand is you, how do we sell this?”

Of course, Mr. Doe’s story doesn’t end there. It’s really just the beginning. While Mr. Doe would like to go back in time and do some things differently, it may not be too late for him to prepare his company for sale. He can start by grooming management, transferring relationships and establishing processes.

Who will buy my business?

How does Mr. Doe find the right buyer to achieve his goals – both for his retirement and his business? It begins with an understanding of the types of buyers for your business.

Most buyers can be classified as either strategic or financial buyers.

Strategic buyers typically buy 100 percent of your business and assume all responsibility for it. Examples include:

  • Family members. There are some great companies with great stories about long-term family ownership. We also know of many examples, however, where family ownership has been rife with problems and where company value has declined when the next generation has run the business poorly. A transition to family needs careful guidance, structure and often benefits from an unbiased third-party consultant.
  • Employees. This is very appealing to some owners who want to take care of their people, and there are various strategies to structure these types of transactions, such as an Employee Stock Ownership Plan. However, relatively few employee groups have the financial capacity to pay an owner what the business is worth.  
  • Outside party. This would include competitors, suppliers and even customers.

The benefits of a strategic buyer can include:

  • The potential to combine the business with another, creating a more powerful entity and gaining entry to new markets.
  • Capitalizing on the synergy that comes with a buyer who has intimate knowledge of your business.
  • Liquidation of 100 percent ownership.

Concerns with a strategic buyer may include cultural differences that make integration difficult, or sharing information with competitors who may or may not buy your business.

Financial buyers are groups such as:

  • Private equity groups.Private equity groups (PEGs) are firms that raise funds, invest in companies and then exit, hopefully at a gain. Each group generally has certain types of industries and company sizes they like to invest in.
  • Venture capital firms.
  • Hedge funds.
  • Family offices. This entity operates similar to a private equity group, but is unique in the fact that it is established solely to manage a family's wealth. As a result, family offices control their own wealth and are not required to work with other investors, which allows for quicker decision making and more flexibility with respect to investment timelines. Furthermore, these organizations are less restricted in their selection criteria for investments.

Selling to one of these groups may actually mean you end up selling your business twice. Many of these buyers invest in businesses they feel they can grow and increase marketability for a future sale. They may buy 75-80 percent of your business’s equity now and sell the business five to seven years later. You will be paid out your remaining equity then, and in some cases this 15-20 percent will be the same or more than the original sale of 75-80 percent of the company.

Concerns with a financial buyer are the buyer will often require majority ownership, so the management team and the buyer group should share the same goals and have good chemistry.

How Do I Sell My Business?
Selling your business is more than a tour of the office, a handshake and exchanging a check. It can be complicated, often messy and intense. It may take up to six months of data gathering, negotiations, analysis and various emotions before it’s over.

Step One – The Nondisclosure Agreement
The first step is giving the potential buyer just enough information to help determine a price. It’s important that you don’t give a potential buyer any information until they have signed a nondisclosure agreement. This will protect your information and ensure the buyer is only using it to formulate an offer.

Step Two – Indication of Interest
After preliminary due diligence using the information you have supplied them with, as well as other research, the buyer will typically give a range of value for your business in the form of an Indication of Interest. If you like what you see in this, then you can give the buyer more access to your business’s information, including key contracts or agreements, customer lists or more detailed financial information.

Step Three – Letter of Intent
Once the buyer has a cohesive picture of your business, they can hone in on a more precise value. This is laid out in the Letter of Intent, which covers the purchase price, the structure of the deal, whether it is an asset or stock sale, the escrow parameters, the working capital allowance, and other details. While this is a very intentional document, it is non-binding.

Final Step – Purchase Agreement
After negotiation, review of legal terms and final due diligence, a purchase agreement is created. This binding agreement is agreed upon by both parties and will be a road map for how things play out once the deal is closed.

What are the next steps I need to take to prepare for exit?
There are several steps to take if you are thinking about selling or transitioning your business now, or in the future. First, it is important to get a realistic expectation of what your business is worth now and how to increase that value. In addition, it is helpful to truly understand what your transaction options are.

Even if a potential exit is years away, it's important to focus now on key business issues, develop a planning process for the future exit and coordinate services with a wealth management team. Get advice from trusted business advisors and people who have gone through these situations before. They’ll help you navigate the bumps along the way and make sure you can move on with confidence and peace of mind.

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