One way or another, every business owner will exit their venture some day. The lucky ones will get to leave at the right time and transfer the business to the people they choose, riding into the sunset with enough money to do whatever it is they want to do. This is called the “vertical exit” – walking out the front door on your own terms.
How do you start planning for a vertical exit? You start by identifying the key components I just mentioned: the right time, the right people, and the right amount of money.
The timing
Start with narrowing down a specific time for your exit. If I had a nickel for every time a business owner told me they wanted to bow out in 3-5 years, I’d be at least $50 richer. Planning an exit starts with getting specific but also with understanding that you may need to be flexible on the timing. It makes a difference in how you approach the planning process when you stick a pin on a calendar as a way of saying, “This is the day I start doing something different with my life.”
The people
Next, you must visualize the people you might want to succeed you. Sometimes the answer is obvious, such as a partner or a child already involved in the business. Other times, the answer is not so clear. Perhaps you have a management team eager for ownership but lacking the complete skill set to ensure continued success, or you have attracted interest from third parties. In some cases, the business might not have enough transferable value to do anything with, and liquidation is the only option.
Exit paths
Deciding on a viable exit path for your business is another major step. Once you have identified one or more options, you can begin exploring what you need to do to make them happen successfully.
There are six common ways to transfer business ownership: an initial public offering (IPO), a sale to a third party, an internal buy-out (partner, manager, or ESOP), a family transfer and/or gifting, a phase-out, and a liquidation.
IPOs are the preferred option for businesses that generate a huge amount of primary market interest. When that happens, an investment bank takes the company public. IPOs are the least common way of transferring ownership.
A sale to a third party only closes for roughly one out of five businesses that go on the market. Nevertheless, it’s one of the most popular initial exit paths when an internal option is not readily available.
Internal transfers – which include partner buy-outs, management buy-outs, and employee buy-outs – usually make up the bulk of successful business transfers. Partner buy-outs are the most common occurrence, while ESOPs (employee stock option plans) are the least common.
Family transfers happen quite often, but they can be complicated by interfamily dynamics, estate equalization issues, and gift tax laws. However, when properly structured, they can be very successful. It’s especially important in family transfers that the retiring owners have a nest egg built up so the successors are spared the burden of being financially responsible for their parents.
Phase-outs occur when owners slowly transfer responsibilities to managers and/or family members but maintain controlling interests with access to distributions. Phase-outs are popular when the owners haven’t saved up enough money to retire outright and can slowly transfer responsibilities. However, this option comes with its own complications, especially when key managers, partners, or family members resent their efforts being used to subsidize the owners’ lifestyle in retirement.
Liquidations are usually a last resort, chosen when no other exit path seems reasonable.
The money
Finally, you must have a clear idea of what you need to get from the business to be able to do what you want to do later in life. Your financial advisor should do a “gap” analysis, looking at your projected savings at the exit date and the net amount (after taxes and fees have been paid) you need to receive from the sale or transfer of the business. Too many owners get focused on the sale price and neglect things such as capital gains, depreciation recapture, commissions, and legal and tax prep.
Once you have set a date, decided on at least one viable exit path, and worked with your financial advisor to project the net proceeds, the really fun part of succession planning can begin. Things can certainly happen along the way, such as bad economic conditions forcing you to push back the exit date, but the sooner you have an exit plan, the sooner you’ll be able to manage those situations and position your business for continued success.
What if…?
Sometimes life happens, and things don’t go as planned. You might fall ill, get injured, or die too soon. This is the “horizontal exit” – being carried out of the office, as it were. The good news is that you can take steps to protect your loved ones and yourself in case you don’t get to exit your business the way you want. With proper planning, you can still have a lot to say in how a horizontal exit happens.
If you have any questions, please don’t hesitate to reach out to us today.
Andrew Dickens
