Business Management Articles
The Six Essential Elements of an Effective Exit
Jason Kwiatkowski
Management Magazine
January 2010
In the coming 15 years, the U.S. and Canadian economies will experience an unprecedented increase in the number of businesses for sale. Baby boomer entrepreneurs will be retiring. Studies indicate that up to 40% of these owners plan to exit their businesses within the next five years, with up to 80% retiring within a decade*. This will be the largest transfer of private wealth in history.
The increasing supply of businesses for sale will likely put downward pressure on sale prices. Thus owners and their management teams will need to focus on doing everything possible to increase the attractiveness, value and salability of their businesses.
Add Value with an Exit Plan
At the same time, most private business owners are not prepared for an exit – they have no formal exit plan in place. Rather than being proactive, owners tend to be reactive and are often “forced” to sell without the time to prepare correctly because of burnout, health issues, marital problems or business conditions. As a result, too many business owners exit their companies at the worst possible time and can regret their decision.
Given the number of companies that will be coming to market in the near future, owners will need to focus on growing revenue, improving profitability and strengthening the depth of the management team in order to make their companies more attractive and to maximize the proceeds they receive at the time of exit. A proper exit plan can deliver these results.
An exit plan is a formal document setting out what steps must be undertaken in order to accomplish an owner’s goals upon retirement. It addresses the business, personal, financial, legal and tax issues that are involved in exiting from a privately owned business. This plan is designed to be a road map for owners to ensure their retirement goals are accomplished, including maximizing net proceeds upon the sale of the business.
There are important benefits to having a formalized exit plan. A well designed and implemented plan enables the owner to:
- control how and when the business is exited;
- maximize company value in good times and bad;
- minimize, defer or eliminate capital gains taxes upon the sale of business;
- achieve business and personal goals; and
- reduce tension among the owner, family and employees.
The Essential Elements of an Exit Plan
In order to be effective, an exit plan must include six essential components.
1)Goals Assessment
The plan should begin with a concise statement of the owner’s personal, financial and business goals, which provide a frame of reference for the plan.
In order to be effective, goals should be specific, measurable, achievable, realistic and motivational. “Maximizing my company’s value when I exit,” for example, is not specific or measurable. “Growing my company from a valuation of $15 million to $25 million within five years so I can retire and net at least $16 million,” is a more effective goal.
2) Financial Needs Assessment
Once goals are established, the next question becomes “What amount is needed upon exit (i.e. sale of the business) in order to accomplish my goals?” This is the main objective of a financial needs assessment. This assessment also ensures that the owner’s goals are realistic and helps to identify a course of action for the business.
The assessment requires making certain assumptions in order to arrive at an estimated lump sum amount the owner will require upon exit. These assumptions may relate to annual spending requirements in retirement, rates of return expected on retirement, inflation rates and life expectancy. A financial planner can assist with this component of the exit plan.
3) Business Valuation
After establishing goals and quantifying the amount needed at retirement, it is necessary to take an inventory of the owner’s assets, including the value of the business. An independent business valuation will establish a baseline value for the business and help to identify specific ways to enhance its value prior to exit. If value can be increased by 10%, 5% or even 1% through this exercise, it is not difficult to see that the benefits far outweigh the cost of the valuation.
Common valuation approaches for going concern businesses include cost, income and market approaches. Since blindly applying industry rules of thumb often leads to erroneous value conclusions, a professional business valuator should assist with the valuation. The valuator can also provide recommendations regarding how to enhance value over time.
4) Exit Alternatives Analysis
Exiting a business means different things to different people. In general, owners exit their businesses through either an internal or an external transfer. Internal transfers involve sale to family members, existing shareholders, management team or employees. External transfers include a third party sale, refinancing or going public.
To be effective, an exit plan must assess the pros and cons of each exit option as it relates to the circumstances and stated goals of the business owner.
5) Net Proceeds Analysis
After selecting appropriate exit alternative(s), the net proceeds to be received under each alternative should be estimated based on an assumed sale price. It is important that the business owner understands that the actual net cash received upon sale can be significantly lower than the agreed upon sales price. Net proceeds represent the net amount the owner retains upon sale after paying liabilities, income taxes and other obligations.
Whereas the seller is interested in net proceeds, buyers are generally interested in a company’s enterprise value (value to both debt and equity holders). Depending on the exit alternative and transaction structure (asset vs. share sale), enterprise value is increased by non-operating assets (redundant cash or investments) and decreased by the debt, non-operating liabilities, closing expenses and corporate and personal taxes to be paid on the transaction.
With a proper exit plan in place, an owner can minimize taxes and other obligations that must be settled upon sale. A tax accountant or lawyer can assist with this component of the exit plan.
6) Action Plans
An exit plan also requires action plans for the owner(s) personally and for the business. Action plans should identify the specific tasks to be undertaken (such as improving depth of management, preparing a contingency plan, diversifying the sales base, developing a strategic plan, etc.), their timing, the individual(s) responsible and the specific steps involved.
Finally, regular meetings should be scheduled with those accountable for the implementation of the exit plan and the lead advisor to ensure that goals are achieved.
Ultimately, companies that have invested the time and effort to prepare for sale will ultimately sell for a significant premium over those that come to market unprepared. The time to act is now. Contact a trusted advisor like your accountant, lawyer or financial advisor or a certified exit planning advisor to begin the exit planning process.
What’s the likely return on investment associated with implementing a proper exit plan? Priceless.
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*Source: CFIB Research Business Transition a Literature Review May 2004
