Management November 5, 2015 23 Reads share

How To Plan Your Exit Strategy When You Begin Your Business

To a new entrepreneur, the first years of a business seems like the time to focus on immediate growth, not on a future exit. But when your business is still in its infancy, that’s exactly when you should start thinking long-term.

Planning an exit strategy may provide protection against potential loss and financial hardship down the road. Moreover, many of the options available to you when you plan ahead may disappear as the years pass. You may have a vague idea that, one day, your son or daughter will take over the family business, or you may prefer to go out big by selling to an outside buyer.

However, these opportunities don’t just materialize when you’re ready, and there are steps you can take along the way to increase your options.

Strategize your exit now, not later

Entrepreneurs who don’t take time to contemplate their eventual exits face two unfortunate prospects:

  1. not being able to sell the business due to debt or lack of revenue,
  2. or never realizing the full value of the company.

There is also the risk of not being able to leave the company in the hands of their chosen successors.

According to a 2010-2011 PricewaterhouseCoopers succession planning study:

  • 40% of family business owners who were surveyed in the U.S. said they had no succession plans in place.
  • 79% said their businesses have been family-run for two or more generations,
  • and 55% said they’re contemplating transferring their businesses to the next generation.

However, many may not be able to do so because they don’t have appropriate plans in place, or their successors don’t have the necessary leadership training or skills.

A transition often fails to live up to its owner’s expectation because the preferred successor doesn’t have enough capital to buy the company. Although it seems counterintuitive to train someone on how to buy you out, the original owner must be involved in the transition to be successful. By establishing your exit plan many years in advance, you can take steps to see your company’s value realized and facilitate the transition to someone you trust.

Don’t learn lessons the hard way

In 1985, my father decided he wanted my brothers and I to eventually run our family business, so we arranged a buy-sell agreement that we would fulfill when he passed. We intended to buy stock from our mother as part of our dad’s estate and use that to buy the company.

Unfortunately, he died of cancer soon after the agreement was put in place, and we discovered there wasn’t enough life insurance to purchase the required stock. Worse, my two brothers and I owned equal shares in the company, so no one had majority control, making it even more challenging to make the tough decisions needed to save the company.

We ended up taking money out of the company to cover the difference. If my father had started planning for the transition sooner and properly funded the plan, we would have avoided the loss and heartache that came on top of our grief of losing our father.

You build a company to make money, innovate, and provide for your family and community. You don’t want your years of hard work to crumble due to poor management when the business transitions— you want to exit in style, as John H. Brown puts it.

Exit in style

Use the following questions to begin strategizing for an exit on your own terms:

#1. Who do you want to lead the company?

Begin grooming someone early to fill your shoes, whether it’s a family member or key employee. Have that person rotate through different posts to gain a solid understanding of what it takes to run the organization on a daily basis. Also, include them in your overall strategy. This positions your successor, and the rest of the company, for a smooth transition.

This should be obvious, but only hire top-notch people. Business owners rely on communities of smart, motivated team members to create and grow value within the organization. In order to work yourself out of a job, bring in people who think like entrepreneurs and have commitments to excellence. Innovative, efficient employees are valuable assets, and one of them may stand out as a natural leader as you approach the years leading up to your exit.

#2. When do you want to exit?

There is no formula for determining the right time to sell. Serial entrepreneurs may want to build a company quickly, and then sell it as fast as they can. The head of a family business, however, might want to remain in charge until he or she reaches retirement age — or later. It’s a personal decision, but you need to think through your preferences and contingency plans well in advance of your departure.

Consider how much money you’ll need to maintain your lifestyle after you sell. Look at this through the lenses of personal, retirement, and estate planning. That way, you don’t run into any financial surprises after you retire. Because estate taxes can be your largest liability, determine your liquidity needs and enhance your strategy to preserve your estate’s value and efficiently transfer wealth to your family and heirs.

#3. What is the company’s value?

Some business owners mistakenly treat their companies like hobbies and fail to invest the capital and resources needed to pursue growth. But buyers look for profitable operations that generate consistent cash flow because that’s how they make returns on their investments. Always protect the golden goose — your business’s ability to make money.

To ensure long-term profitability, you must establish good accounting controls and verify all transactions. I knew an older gentleman who wanted to sell his business, only to find out that an associate had bled the company dry. Without the proper accounting controls, he had no idea what was happening within his own organization. This is a disastrous scenario and will make it impossible to have a lucrative, successful exit.

#4. What incentives are in place?

Long-term incentives enable you to retain quality employees who can one day assume control of the company. Offer stock options after they’ve proven their capabilities, and increase their shares over time. Other options include nonqualified executive incentive plans that can be used to recruit, retain, and reward key people. A business owner can explore may options in this area; options that will help retain key people and that will create and grow value to ultimately help develop an exit plan.

Golden handcuffs are essential to protect your interests with the person you’ve selected to succeed you in leading the business. If he or she receives an offer from a competitor, you may need to sweeten the deal to stay with your operation. This may include specially designed incentive plans that can be implemented for key executives; phantom stock; stock appreciation rights; a company car; increased salary; extended vacation time; and family benefits. These make it much harder to leave.

Exit strategies aren’t something to be dealt with at the last minute. Transferring control of your company to someone else is a lengthy, complex process — you need to protect yourself, your company, and your successor. Take time now to plan for your exit with your team of trusted advisers, and coach the person you’ve chosen to take over to ensure a seamless, profitable transition in the future.

Images: “Man Hand writing What’s My Exit Strategy? with black marker on visual screen. Isolated on office. Business, technology, internet concept. Stock Photo /  Shutterstock.com

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Peter Racen

Peter Racen

Peter Racen is an estate and business planning specialist and wealth management advisor for Northwestern Mutual. He works with a variety of business owners concerning business exit analysis, estate accumulation and distribution, and incentive plans to attract top people to retain these businesses.

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