WHY EXIT PLAN IS IMPERATIVE FOR ENTREPRENEURS
Many first-time entrepreneurs have questioned the need for an exit plan, or harvest plan, because they are more concerned with launching the business and making it a success than with thinking about how they are going to get out. But even though some entrepreneurs stay with their new ventures for the long-term, the majority enjoys the challenge of start-up and the excitement of growth and abhors the custodial role of managing a stable, mature company. Consequently, exiting the business does not necessarily mean exiting the role of entrepreneur. It may in fact mean taking the financial rewards of having grown a successful business and investing them in a new venture.
There are entrepreneurs who do that very thing over and over again throughout their lives and in the recent past we have seen more and more entrepreneurs build businesses to “flip”, that is, to take public or sell to a larger firm. In other cases, when the venture reaches a certain size, the business needs professional management skills that the entrepreneur does not possess. In fact, the entrepreneur may actually be holding the company back without realizing it. Whether or not an entrepreneur intends to exit the business at that point, there should be a plan for harvesting the rewards of having started the business in the first place. Entrepreneurs need to think of their companies as part of an ongoing career path. There are four major types of career paths for entrepreneurs.
- Growth entrepreneurs
These are entrepreneurs who measure their success by the size of their company. They tend not to have an exit plan because they’re striving for bigger, better, faster.
- Habitual entrepreneurs
These are people who love to start businesses and may start and run several at once. They are probably even less likely to have an exit plan because there are always new opportunities out there.
- Harvest Entrepreneurs
These entrepreneurs start and build a venture for the purpose of selling it. Some of these owners will start, build, and harvest many companies during a career.
- Spiral, or helical, entrepreneurs
Women entrepreneurs often fall into this category. These entrepreneurs are driven by what is going on in their personal lives, so their entrepreneurial tendencies emerge in spurs. At times they may appear oblivious to the business as they deal with family issues.
Strategies by Which an Entrepreneur Can Achieve a Rewarding Harvest
It is never too early to begin to think about an endgame strategy, so that the exit will be graceful rather than “feet first”. There are several methods by which an entrepreneur can achieve a rewarding harvest.
Selling the Business
Selling the business outright to another company or an individual may be the goal if the entrepreneur is ready to move on to something else and wants to be financially and mentally free to do so. Unfortunately, however, selling a business is a life-changing event. For several years, the entrepreneur has probably devoted the majority of his or her time and attention to growing the business, and it played an important role in structuring the entrepreneur’s life. When the business has been sold, the owner may experience a sense of loss, much like what accompanies the death of a loved one. If the owner has not prepared for this change, emotional stress could be the consequence. Therefore, planning for the enormous change will be very important.
The best way to sell a business is for the entrepreneur to know almost from the beginning that selling is what he or she wants to do. In this case, the entrepreneur will make decisions for the business that will place it in the best position for a sale several years later. For one thing, the business will need audited financial statements that give the business forecasts more creditably. The tax strategy will not be to minimize taxes by showing low profits, but rather, to show actual profits and pay the taxes on them, because the entrepreneur will probably more than make the business worth more. Business expenses and activity should be kept totally separate from personal expenses. It will also be more important to plan for the time it will take to sell the business and wait to sell until the window of opportunity has opened.
Smaller businesses for sale often use the services of business brokers; however, a high-growth venture is more likely to employ the services of an investment banking firm that has experience with the industry. Investment banks normally want a retainer to ensure the seriousness of the commitment to sell, but that retainer will be applied against the final fee on the sale, which averages 5 percent of the purchase price. It is recommended, however, that a third party with no vested interest in the sale be enlisted to judge the fair market value of the business. This “appraiser” can also prepare financial projections based on the history of the company and the appraiser’s independent market research.
When a business is sold, the entrepreneur does not have to sell all the assets. For example, the building could be held out of the sale and leased back to the business purchaser, with the original owner staying on as the landlord.
While the potential purchaser is conducting due diligence on the entrepreneur and the business, the entrepreneur needs to do the same with the purchaser. The purchasing firm or individual should be thoroughly checked out against a list of criteria the entrepreneur has developed. The purchaser should have the resources necessary to continue the growth of the business, be familiar with the industry and with the type of business being purchased, and have a good reputation in the industry, and offer skills and contacts that will ensure that the business continues in a positive direction. In order to compare one buyer with another fairly, it is often helpful to make a complete list of criteria and then weigh them to reflect their relative importance.
Cashing Out but Staying In
Sometimes, entrepreneurs reach the point where they would like to take the bulk of their investment and gain out of the business but are not ready to cut the cord entirely. They may want to continue to run the business or at least retain a minority interest. There are several mechanisms by which this can occur
- Selling the Stock
If the company is still privately owned, the remaining shareholders may want to purchase the entrepreneur’s stock at current market rates so that controls don’t end up in other hands. In fact, the shareholders’ agreement that was drafted when the entrepreneur set up the corporation may have specified that shareholders must offer the stock to the company before offering it to anyone else. If the company is publicly traded, the task of selling the stock is much simpler; however, if the entrepreneur owns a substantial portion of the issued stock, strict guideline set out by the SEC must be followed when liquidating the shareholder’ interests. If the company has a successful IPO, founders’ stock will have increased substantially in value, which represents a tax liability that should not be ignored. That is why many entrepreneurs in such situations cash out only when they need to support whatever goals they value. This strategy, of course, is based on the presumption that the company stock will continue its upward trend for the foreseeable future.
Entrepreneurs who want to cash out a significant portion of their investment and turn over the reins to a son, daughter, or other individual can do so by splitting the business into two firms, with the entrepreneur owning the firm that has all the assets (plants, equipment, vehicles) and the other person owning the operating aspects of the business while leasing the assets from the entrepreneur’s company.
- A Phased Sale
Some entrepreneurs want to soften the emotional blow of selling the business, not to mention softening the tax consequences, by agreeing with the buyer – an individual or another firm – to sell in two phases. During the first phase, the entrepreneur sells a percentage of the company but remains in control of operations and can continue to grow the company to the point at which the buyer has agreed to complete the purchase. This approach gives the entrepreneur the ability to cash out a portion of his or her investment and still manage the business for an agreed-upon time, during which the new owner will probably be learning the business and planning in.
In the second phase, the business is sold at a pre-arranged price usually a multiple of earnings. This approach is fairly complex and should be guided by an attorney experienced in acquisition and buy-sell agreements. The buy-sell agreement which spells out the terms of the purchase specifies the amount of control the new owner can exert over the business before the sale has been completed and the amount of proprietary information that will be shared with the buyer between Phases 1 and 2.
- Joining a Roll-Up
In recent times, the consolidation play has become a way for many business owners to realize the wealth they have created in their businesses. This is how it works. A large established company finds a fragmented industry with a lot of mom-and-pop-type businesses. The consolidator buys them up and puts them under one umbrella to create economies of scale in the industry. The local management team often stays in power, while the parent company begins to build a national brand presence. The payoff for the entrepreneur comes when the consolidator takes the company public and buys out all the independent owners. It is important to conduct due diligence on any consolidator, because one’s ability to cash out will be a function of the consolidator’s ability to grow the company and take it public.
If you find this article useful, please share and subscribe to our newsletter.