Welcome to our class on “How to Start a Business”, our first topic is on “Exit Strategies”! This opening never fails to get a class full of raised eyebrows, but I’m convinced that considering your exit strategy is an exercise every small business should start with and periodically review.
Starting with your company name…
…most of your decisions will be affected by your exit strategy. Let’s say you want to build your plumbing business over a few years and then sell. Using your name as the brand will detract value for a new owner with a different name. The legal entity; C-corp, S-corp or LLC, that you choose is another big decision made early in the start-up process that can be dependent on your exit strategy. Hiring employees, the value model, buy or lease decisions – your exit strategy may effect all these decisions, which is why I encourage every small and medium business to have one.
In a controlled dissolution exit strategy the business stays in operation as long as the owner is working. When the owner decides to stop working the business is done. This exit strategy is typical of many professionals who are the primary revenue generator for the company – a consultant who bills all the hours or a plumber who does all the labor. There is no passive revenue and the value of the business is basically zero without the owner’s daily involvement.
There is nothing wrong with this exit strategy, as long as it is a conscious decision and the owner plans the rest of the business around it. For instance, the value model is that you pull out as much cash as possible and invest in outside resources, which means the marketing strategy should maximize profitability and cash flow.
An ownership transfer exit strategy is one in which the owner plans to sell his ownership to another party in whole or in part. The most common transaction for smaller businesses is a complete sale to another person or another company. For a few entrepreneurs with the right business concept, “going public” is a valid strategy where the “sale” of the company is to many outside investors on a public stock exchange.
In an ownership transfer exit strategy the value model is about building “transferrable” value. This is the kind of value that can be realized even in the absence of the owner. With this exit strategy the sky is the limit for your return on investment. The value of the company can be a passive revenue stream, typical of insurance agencies, or the potential for growth from a new technology, a high value customer mix or demand for a specific product or process that you own. In general owners with this exit strategy should always be looking for ways to make the business less dependent on them through solid processes and a strong work force. That will make the business much more valuable to any potential outside buyers.
Transition to Passive Investment
This exit strategy is used very often in family businesses. As the kids are able (and willing) to take over the business, ownership is sold or gifted to them over time. The owner either sells them the business and finances it over a number of years, or maintains a diminishing ownership stake as they buy ownership through the transition process. The passive income for the owner is in the form of principle and interest payments on a long term loan, additional sale of their ownership and distributions from the profit of the company over time.
This is a solid strategy when done correctly. First of all, it is imperative that the owner ensures the transition of operations is to someone competent, because if the business fails, the passive income source is done. Also, if you are dependent on distributions or dividends as an income source, make sure the new ownership is planning to make those. If they decide to put everything back in the company, your income source could dry up quickly.
Pick One and Decide Accordingly
Picking an exit strategy is not about predicting the future and yours will probably even change over time. The important thing is to have one in mind so that when you make daily decisions they are based on a long term vision, not just a gut feel for what’s easiest at the time.
Of course there are many variations and nuances to exit strategies and I’d love to hear about your experiences or struggles in deciding on and implementing an exit strategy. If you need help in this area give Sigma College of Small Business a call and we can help.