Developing An Effective Exit Plan

According to a 2005 PricewaterhouseCoopers survey of companies in the $5,000,000 - $150,000,000 of value range, two out of three business owners plan to leave their company within the next 10 years. Yet, only 22% of them report having done a great deal of Exit Planning. In fact, business owners are more likely to have plans in place should they become disabled than they are to have plans for their own voluntary – and inevitable exit! Given that their exit from their company is likely to be the most significant financial event of their life, what are they waiting for?

Business owners should not make the mistake of assuming that since they may have a buy-sell agreement, shareholder agreement, or other succession planning document in place, that they have prepared an Exit Plan. They have only scratched the surface. Exit Planning is the deliberate, adaptable, and customized process that a business owner uses so that he (or she) can leave his business on his terms and according to his schedule.

The three principal exit objectives common to nearly all business owners (and the questions that must be answered in setting these objectives) are:

Exit Planning involves a seven-step process to help business owners formulate, document, and implement an effective Exit Plan intended to help them achieve their long-range objectives.

Establishing Owner Objectives. The obvious starting point is to identify the business owner’s objectives. Determining their objectives regarding the exit of their business generally can be accomplished by answering these questions: When do they want to sell their business? What is the annual after-tax income they want after they sell their business? To whom do they want to transfer their business?
Establishing Business Value. While the first step establishes what the business owner wants or needs in order to leave their business on their terms, this step determines what they have now. In other words, what is their business worth today? Determining the current value of the business tells us whether there is sufficient value in the business to support the business owner’s post-exit income needs. If the current value falls short of this objective, part of the exit plan will be to increase the value of the business to a minimum acceptable level. This valuation issue also must be viewed in context of their likely successor for the business. If their exit plan involves transferring the business to family members or key employees, a lower business valuation may be preferable. On the other hand, a sale of the business to a third party may require the absolute highest possible valuation for the business.
Building Value and Cash Flow. A critical part of an exit plan is working with the business owner’s advisors to develop and enhance the key value drivers for the business. These value drivers include: an effective management team, efficient operating systems, an established and diverse customer base, a realistic growth strategy, effective financial controls, a stable and increasing cash flow, and a tax efficient business structure. Working on these value drivers now will help ensure that the business is best positioned to fulfill the business owner’s exit objectives.
Selling to a Third Party for Top Dollar. This step focuses on two primary objectives. The first is to find a buyer willing to pay absolute top dollar for the business through a controlled auction, a negotiated sale or other method. The second objective is to ensure that the sale is structured to maximize the after-tax proceeds to the business owners.
Transferring to Management or Family Members. If the business owner’s objective is to sell or transfer the business to management or family members, the Exit Plan will be structured very differently than a plan contemplating a sale to a third party. In general, a sale to insiders does not end with a closing. It only ends when the business owner gets paid. The primary obstacle with a sale to insiders is that the buyer lacks cash. This type of sale will generally be dependent upon the ability of the buyer to purchase the business out of future cash flow. This is why we often times try to create other revenue sources for the owner (such as deferred compensation, rent obligations, increased retirement benefits, etc.) that will allow for a lower “sales price” for the business itself.
Developing a Contingency Plan for the Business. Generally, owners have a more pleasant ending in mind when they think of exiting their businesses, but an effective Exit Plan must address the possibility of the business owner’s death or permanent incapacity. Without continuity of ownership, the business hits the wall. If ownership transition is uncertain, business continuity is not only uncertain – it is doubtful. Failure to be aware of all the dire consequences upon a business in the event of the owner’s death can mean the unintended demise of the business along with its owner. A contingency plan must be developed and documented so that the business can continue, and its value be preserved, even if something happens to the business owner.
Family Wealth Preservation Planning. The business owner’s Exit Plan must contain the proactive design and implementation of wealth preservation strategies before ownership of the business is transferred. An effective wealth preservation plan will protect the value of the business currently, as well as in the event of the owner’s unexpected death or permanent disability. Wealth preservation also encompasses the owner’s plan for transferring wealth (either in the form of the business itself or exit proceeds) to future generations.

Too many business owners make the mistake of thinking that the time to develop an Exit Plan is when they are ready to exit their business. Unfortunately, once they reach that point most of the value that can be provided by developing and implementing an effective Exit Plan has already been lost. The time to begin developing an effective Exit Plan is today. This will require a significant investment by the business owner in terms of both time and resources. However, if they choose to make this investment, they may well look back at it as one of the wisest investments they have made in their business.