A business exit strategy is a strategic plan to sell or walk away from a business. You can sell a business with desirable assets for a profit and/or work as a manager. Typically, business owners plan their exit five years in advance, giving them time to maximize the business’s value for investors.
Before selling your business, it’s a best practice to have an attorney review any legal documents involved in the sale. Rocket Lawyer provides affordable and convenient legal advice from business attorneys. It also provides several contracts related to selling a business, like a business sale agreement. Sign up to get started with Rocket Lawyer today.
How a Business Exit Strategy Works
It’s wise to strategize your exit during the planning stages of a business. Often, business owners include the desired exit strategy in the business plan. There are many ways to exit your business and, knowing how you’d like to exit guides business decisions regarding management and product development.
For example, if you’d like to pass on the business to a family member, you should consider giving them a position in the company at least five years before exiting. This will help the family member learn business systems and values. If you’d like to transition your business to a passive or lifestyle business, you could transition the business to ecommerce before you exit. An ecommerce business can potentially be operated from your home and automated.
A business exit strategy often includes a business valuation, which is a calculated assessment of what the business is worth. Ultimately, the business is only worth what a buyer will pay for it. However, it’s essential to know your business’s value before entering a negotiation. There are several ways to approach business valuation. We recommend that you get an evaluation from an expert rather than a freehand calculation because am expert opinion carries more credibility with the buyer.
Additionally, it’s important to build a team of trusted advisors before going through the business exiting phase. A team of professionals like an attorney, a certified public accountant (CPA), personal financial planner, banker, and business appraiser will guide you through the selling process. For a larger business sale or transition, consider using a value advisor or a certified exit planning advisor (CEPA) to assist with the decision making.
Preparing for a Business Exit
Before implementing your business exit strategy, it’s best to start preparing for a business exit at least three to five years in advance. This gives you enough time to determine your personal financial plan, take action to maximize business value, receive an accurate business valuation, and build a team of trusted advisors.
Personal Financial Plan
It’s important to consider what your life after selling the business will look like. Will the proceeds from your exit strategy be sufficient to meet your financial needs and wants? Before exiting, consider your composition of wealth. Do you need the business to provide an income stream after your exit, or can you live comfortably on the proceeds from the business sale?
Business Value Maximization
Before exiting and selling your business, there are steps you can take to maximize business value. Strategic buyers will pay more for a business that has well-documented processes in place.
Some of the assets a buyer is purchasing are the business systems you have built through the years. Additionally, buyers want to see a high-quality brand and solid customer relationships to help ensure their future success with the business. For example, collecting information about your customers like name, email, and address may increase the value of your business.
There are three main ways to value a business: asset approach, income approach, and market approach. The asset approach uses the current value of assets to determine a fair market value and is used when a business’s assets are more valuable than the business itself. An income approach uses discounted cash flow, which is a valuation based on anticipated revenue, to arrive at a value. A market approach arrives at a business value by using recent sales of comparable businesses.
Leading up to the exit of a business, you should have a team of trusted advisors. An attorney will assist with the legal documents. A CPA will help to maintain clear financial records leading up to the exit. A banker will understand your business well and can assist the buyer with financing. Lastly, financial planner or wealth advisor will help factor the sale of the business into your personal financial goals.
13 Ways to Exit Your Business
How to best exit your business depends on your business’s current financial situation. If you’ve built valuable assets in the business like a customer base, business systems, effective employees, and proprietary information, there are several business exit strategies available to you. If you haven’t built a valuable business and struggle to sell it, you may have to liquidate, close, or file for bankruptcy.
1. Sell to Unknown Entity
A common way to exit a business is to sell on the open market. This is when you sell your business to an unknown entity. The entity can be a single person, multiple owners, or a group of investors. You can attempt to sell your business on a website like BizBuySell or BizQuest. A benefit of selling the business yourself is that you save on costs like business valuation, marketing, and business broker fees.
If you want to work with a professional, consider hiring a business broker. They assist with marketing the business and showcasing it to buyers. Business brokers may also help prepare the business to look as appealing as possible to a buyer.
The fees for a business broker vary depending on the size of your business. A broker may charge a 10% fee on the final purchase price and $1,500 for marketing when selling a smaller business. A larger business may have a lower percentage fee but have marketing costs of more than $10,000.
2. Transfer the Business to a Family Member
Many owners who’ve worked hard to build their business want to keep within the family. A benefit of transferring the business to a family member is the limited tax liability. If the business is worth under $5.45 million and it’s gifted, no taxes are owed on the sale. However, a downside of gifting the business is that you won’t receive proceeds from a sale. This may not meet your personal financial goals.
3. Sell to Existing Employees
Instead of relying on the open market to help you sell the business, consider selling to an employee or several employees who are currently working within the business. This is often an easier exit because you can groom an employee to run the business over several years. Selling the business to an unknown entity could require a stressful couple of months of you teaching them how the business operates.
A benefit of selling to multiple employees is that they can spread the purchase cost. One employee may not be able to afford the business. However, spreading the cost over three or four employees makes the business more affordable for each.
4. Sell to Another Owner or Investor
If you have a partner in the business, a simple option is to sell your shares to him or her. If you and your partners drafted a buy-sell agreement, which is a legal agreement you must abide by when selling or making ownership changes to the business, the process should be smooth. If you didn’t draft a buy-sell agreement when starting the business, you can incur substantial legal fees to settle a sale price dispute.
Instead of selling to a co-owner, you can sell your ownership interest to an investor. If the other business partner or partners can operate the business without your involvement, a silent investor may purchase your interest. The silent investor, also called silent partner, is not responsible for making decisions daily.
5. Get Acquired by Another Business
If a business builds valuable assets like a trained staff, client base, or proprietary software, another business may want to acquire or purchase them. For example, Facebook has acquired more than 70 businesses, including WhatsApp, Instagram, and Oculus Virtual Reality. A business like Facebook may acquire a business for several reasons. For instance, it doesn’t want to hire and train additional employees, or the strategy team wants to eliminate competition. Consider pitching the value of your business to competitors to determine if they are interested in an acquisition.
6. Sell the Business & Become an Employee
If another company acquires your business, you can choose to work as an employee. Once the sale is complete, you won’t receive any profit payouts. However, the acquiring business may pay you a salary. The business may prefer hiring you as part of the exit strategy to ensure the acquisition and overall business transition goes smoothly.
7. Transition to Being a Passive Owner
Another business exit strategy is to continue functioning as an owner while decreasing your role within it. This often includes hiring a general manager to take over the day-to-day duties. When you transition into a passive role within the business, you’ll need to reduce your work hours and take a backseat on making daily decisions. Some business owners prefer the passive role instead of outright selling because they want to continue to receive the profit payouts from the business.
8. Create a Lifestyle Business
Another way to exit a business is by creating a lifestyle business, which requires an owner to change the business model to fit their lifestyle needs. For example, if an owner operates a cupcake shop, they can close the shop and transition the business into an ecommerce-only store. Customers order online instead of coming into the store.
An ecommerce business allows an owner to work at home part-time and part-time in the business, a lifestyle they desire. Alternatively, the owner could transition the model to a digital-based business; for example, a cupcake decoration YouTube channel that can be operated from home is a good option.
9. Gift Your Business Ownership Interest
If you want to go with a charitable business exit, you can gift your ownership interest in a business. The gift can be given to a charity, organization, or family member. Gifting ownership interest has tax benefits for the business owner. There are several ways to gift an ownership share, including a one-time transfer or over a period of years.
10. Launch an Initial Public Offering
An initial public offering (IPO) occurs when a business decides to sell its ownership shares to the public. In the event of an IPO, the business owner is expected to give up their ownership shares and transition to another role, such as president or chief executive officer. Companies go public because it can be lucrative for the owners. However, using an IPO as an exit strategy is rare. Typically, a business needs to have at least $20 million a year in revenue and $1 million a year in profits before going public with an IPO.
11. Liquidate the Business
If it’s a struggle to sell a business, the owner can decide to liquidate it. A liquidation is the selling of assets before closing the business. For example, a chiropractic business liquidation would include selling items like computers, tables, furniture, and machines. Liquidating the business is an option many business owners take when they want to exit a business immediately.
12. Close the Business
Simply closing the business is an exit strategy if the business doesn’t have any value or assets. One important note to remember is if you choose to close the business, there can’t be any debts on the books. If there are debts within the business that cannot be paid, the owner will have to file for bankruptcy. With no assets or debts, the business owner can walk away from the business with ease.
If the business has outstanding debts that cannot be paid, filing for bankruptcy is an exit option. This isn’t an option for which many owners plan when starting the business. As a result of bankruptcy, business assets are seized, and the business owner’s credit is damaged. When you file for bankruptcy protection, you’ll most likely need the assistance of a business attorney. It’s important to learn the differences between Chapter 7, Chapter 11, or Chapter 13 bankruptcy and the consequences associated with each type.
Frequently Asked Questions (FAQs) About a Business Exit Strategy
This section includes the most frequently asked questions about a business exit strategy.
How do you make an exit strategy?
To make an exit strategy, you should start by describing your ideal life after selling your business. This can be as simple as writing a paragraph or several pages about your personal financial plan, how much free time you want, and the role you want or don’t want to play in the business.
It’s important to list the steps you need to take before selling the business, such as getting a business valuation and training the new owner. Three to five years before the exit date, make relationships with trusted advisors like an attorney, CPA, and business broker.
Why is it important to have an exit strategy?
It’s important to have an exit strategy so that you can prepare your business for the type of exit you want to make. For example, if you’re going to sell the business outright, you will take steps to maximize its perceived value. If you’re going to become a passive owner, then you will organize the business to have a general manager or CEO. If you’re going to pass it on to a family member, you should hire them to work in the business several years before you exit.
What are common exit strategies a small business would consider?
The most common exit strategy for a small business is selling through a business broker. A business broker showcases the business to potential purchasers and helps facilitate negotiation. Another common exit strategy is to sell the business to a competitor or a similar business in another territory. For example, if you own a tutoring center, you could sell your business to another tutoring center owner in a different country. This is preferable because they already know how to operate the business.
How do you sell a failing business?
A failing business is difficult to sell because selling a business often relies on persuasion. To sell a failing business, the assets within the business have to be more valuable than the losses like the trained staff or equipment. Additionally, a purchaser has to believe that they can make the failing business profitable.
Exiting a business is often an exciting moment for a small business owner. They get to sell their business for a profit or pass it on to a family member. Unfortunately, some exits can’t be planned for, like those occurring during a challenging situation such as a liquidation or bankruptcy. Regardless of the type of exit, you’ll ultimately make, we recommend that you plan your business exit strategy at least three years in advance, so the business can be sold for its maximum value.
Before selling your business, it’s a best practice to have a business attorney review the purchase agreement for any missed clauses and contract vulnerabilities. Additionally, you may have legal questions regarding selling your business. Rocket Lawyer provides 30-minute legal consultations on new topics for $59.99 per consultation. Sign up to get your legal questions answered today with Rocket Lawyer.