Ask most business owners about their exit strategy, and you’re likely to get a blank stare in return. That’s because the last thing on their minds is often when and how they’ll leave a business that they’re concentrating on making as successful as they can. But John M. Leonetti (pictured), founder and CEO of Pinnacle Equity Solutions and author of Exiting Your Business, Protecting Your Wealth, says a good exit strategy is important. We spoke to him about the topic for the Small Business Center.
Small Business Center: What is an exit strategy and do most small-business owners have one?
John Leonetti: An exit strategy is a plan, ideally in writing, for an owner’s eventual transfer of the business to another owner.
Most owners do not have an exit strategy in place because people who run businesses tend to focus a majority of their efforts on being in the game or competing in their industry. In addition, there is a rather significant psychological barrier to overcome as the thought of not being in a business is akin to a type of death for some owners — particularly after they have run their business for a number of decades. Most owners understand the logic of planning for an exit, but typically put it off to some unknown point in the future.
Why is it so important to have an exit strategy?
Most owners have the majority of their wealth in their illiquid, privately-held business. In addition, most owners and their companies have a rather risky and unhealthy co-dependency. In other words, the owner depends on the company for income, perks, and a sense of fulfillment, while the company is dependent upon the owner for strategic, operational, financial decision-making authority, and, in most cases, personal guarantees on company liabilities.
If business owners think about who might own the business after them, it can help to alleviate some of this co-dependency. In most cases, the potential buyer will evaluate the future value of a company based on the business’ strength and its ability to perform without the current owner. If the success of the business is highly dependent on that owner, the value and future of the business is at risk and may affect the successful transition of the company. For instance, are the sales and customer relationships dependent solely on the owner for success? Does the owner make all critical strategic and operational decisions alone, or is there a strong management team in place? A planned exit strategy will help reduce owner dependency and perhaps further empower a management team that can either ascend to ownership, or help a new owner successfully continue to run the company into the future.
How long in advance should business owners begin to plan their exit strategy?
Ideally, an exit strategy is planned at the outset of a business, although because businesses are so fluid, it can be difficult to know what the final version of the business will look like. For a mature company, the sooner a plan is put in place, the better prepared an owner will be when an exit is available, both personally and professionally.
What options do business owners have when designing an exit strategy?
Most owners are not aware that a number of options are available for a customized exit. The private capital markets have changed substantially in the past 30 years, offering transfer alternatives that did not even exist when most owners started their companies. These options include private sales, management buyouts, co-owner buyouts, an employee stock ownership plan (ESOP), and gifting the business to family members. And there is a growing community of professional investors (private-equity groups) that have a surplus of cash to invest in the right opportunities. These private-equity groups can custom design a solution for the right-sized business with the right growth story. But in the end, the appropriate exit strategy is dependent on the both the owner’s personal goals as well at the company’s transferability status, which is based on its financial and operational status.
What are the steps owners should take in preparation to exit?
My book talks about a six-step process that owners can follow to design an exit plan. The planning starts with determining your personal and business goals, and then assessing your mental and financial readiness. After that, you need to identify the exit options that are most aligned with your goals and readiness. When working with a client, we will then discuss the value that the owner can expect to receive based on the exit option they choose. Finally, the process concludes by attending to the executable items, such as taxes, deal structure, and other critically important elements of a plan. When owners follow these steps in order, they will crystallize their goals, determine whether they are ready, and pinpoint the best option and valuation for their situation.
Is it necessary to hire a consultant when planning an exit strategy?
Most owners who decide to do this level of planning work with professional advisers to get their plan in written form and to have someone hold them accountable as they continue to advance toward their goals. The consultant will also educate the owners as they progress through the various phases of the planning. Theoretically, owners can do this work on their own, however, it is likely that without experience in this area, they will make mistakes that cost much more than what they otherwise would have paid an adviser. We offer a free customized readiness report for those who are thinking about selling.
What is the most important thing small-business owners should know when thinking about exiting their business?
The exit is a process, not an event. This process takes time and will impact a lot of people, so owners should put a lot of thought and analysis into it to gain clarity about what the right decision is. In most cases, if owners make the investment of time, they will be rewarded for it. Likewise, if they don’t take the time for this type of planning, then they leave their legacy and wealth to chance.
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Information may be abridged and therefore incomplete. This document/information does not constitute, and should not be considered a substitute for, legal or financial advice. Each financial situation is different, the advice provided is intended to be general. Please contact your financial or legal advisors for information specific to your situation.