Exit Strategy: Transitioning Your Business to a New Owner

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 all business owners together: 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. And many are motivated when there is substantial market volatility and uncertainty. Such circumstances drive business owners to think longer term about their exit plan, whether they need to develop one or reassess their current exit plan as they’re concerned about the impact to their organization and future transition to retirement.

A comprehensive exit plan encompasses every aspect of your transition, including upfront wealth management and retirement planning, preparing your company for a future transition, and evaluating potential exit strategies. Regardless of how you reach the milestone of transitioning your business – whether it’s retirement or a buyer knocking at the door – an understanding of the transition process and a detailed exit plan 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.

A HOLISTIC GUIDE TO EXIT PLANNING

Why start business exit planning early?

Planning early means you have more time to improve your business, processes and value so it’s attractive for a sale and you’re more secure in your decisions when the time comes. After all, who’s to say a buyer will be interested in your business as it stands when you’re ready to sell?

One of the first questions you’ll ask when you transition your business is: Who are my potential buyers? But if you haven’t put energy into exit planning and maintaining a business buyers want to buy, it may not be as easy to answer this question 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?”

“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,” Mr. Doe says. “Everything runs through me. 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 a sale. He can start by grooming the 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 potential buyers. Most are 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. While we often hear great stories from companies with long-term family ownership, we also see instances where family ownership is rife with problems and company value declines because the next generation runs the business poorly. Transitioning to a family member demands careful guidance and structure, and it often benefits from an unbiased third-party consultant.
• Employees. Transitioning to employees is appealing to owners who want to take care of their people. 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 transitioning to 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.
• 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 mean selling your business twice. Many of these buyers invest in businesses they feel they can grow and increase the marketability of for a future sale. They may buy 75 to 80 percent of your business’s equity now and sell the business five to seven years later. You are paid out your remaining equity then, and in some cases this 15 to 20 percent will be the same or more than the original sale of 75 to 80 percent of the company.

One concern with financial buyers is that they often require majority ownership, so the management team and the buyer group should share the same goals and have good chemistry.

Learn more about how industry specific M&A trends can impact your transition plans

GET THE GUIDE

How do I sell my business?

Selling your business can be complicated. It may take up to six months of data gathering, negotiations, analysis and various emotions before it’s over.

Step One – Nondisclosure Agreement

The first step is having the potential buyer sign a nondisclosure agreement and then giving them enough information to help determine a price. Do not give them any information until they have signed a nondisclosure agreement. This will protect your information and ensure the buyer only uses 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’re satisfied their findings agree closely with your own business valuation, 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 home in on a more precise value. They will lay this 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.

If you don’t have an exit plan in place prior to COVID-19, it’s not too late. Now is a great time to see how your organization, and your personal financial situation, will fair under varying conditions. It’s also a great opportunity to model various scenarios and how they will impact your intended outcomes.

What are the next steps to prepare for exit and transition planning?

Whether you are considering selling or transitioning your business now, strategizing for the future or reworking an existing exit plan, there are several important steps to set yourself up for success.

• Plan for yourself

If you don’t have an exit plan, or if a potential exit is years away, “now” is always the best time to focus on resolving business issues, developing a planning process for the future exit, and coordinating services with a wealth management team. Understanding the impact an exit will have on your overall wealth plan is key. A wealth plan is a detailed strategy for how to transition your wealth, whether through inheritance, investments, gifting and more. Identify your objectives, goals and timelines that best fit you, your family and your business. Understand needed financial resources for your retirement, including future cashflow needs and needed retirement funds that will support your retirement. Preparing for these aspects years in advance of an exit will allow business owners to navigate volatility and uncertainty by focusing on important, controllable variables.

• Prepare your business for "the moment"

There is no formula or magic metric to define the "perfect time" to look for a buyer. Rather, you must look at your own long-term business and personal financial goals. Regardless of timing, preparing your company for a transition is an important step of the exit planning process. Factors to consider while planning for a business sale include:

• GAAP Compliance: Clean financial statements are critical to any method of transitioning a business. Early verification that internal bookkeeping is GAAP compliant ensures a smooth exit process down the road. Identifying GAAP deviations and understanding their impact prior to transitioning your business will help prevent unfavorable “surprises” during the exit process. An early understanding of normalized EBITDA and working capital, key metrics evaluated in a transition, will provide insight from the perspective of a potential buyer.
• Key Relationship Transition: All exit plan scenarios will evaluate how a business will operate without its founder. Decrease founder dependency by transitioning key vendor and customer relationships to key employees. A deep management team is an attractive characteristic that will alleviate stress on the business in your transition.
• Key Employee Retention: Understand how your workforce will react with a different leader in charge of your company. Take early steps to incentivize key employees to stay for the long term by providing transparent and achievable performance goals that will be honored by you and your replacement.

• Reevaluate any existing plan

If you already have a strategy in place, your exit plan is ever-evolving and you should constantly reassess and modify it for changing market dynamics. Here are a few things to consider – particularly during and after times of uncertainty or a shakeup in the market:

• Has a change in the merger and acquisition environment impacted who would be your most likely buyer?
• Has your timeline to exit changed?
• Is your management team prepared to navigate market volatility?
• Have you found yourself with more key customer or vendor reliance?

For a successful transition, it’s critical to get advice from trusted business advisors who have gone through such sales and transitions before. They’ll help you understand your transaction options, get a realistic expectation of what your business is worth now, and map out how you might increase that value. They’ll help you navigate the bumps along the way and make sure you can move on with confidence and peace of mind.

Learn more about how to transition your business and what to do next.

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