Small Business Series – Mistake 8: We started this series a few months back with a post about business owners starting an enterprise for the wrong reasons. If the wrong entrance strategy was our first post, it only makes sense that our final post in this series centers on having the proper exit strategy from the business.
Assuming that most small business owners are not intent on using an IPO and becoming a public company as a way to exit their business, there are really three options: (1) Sell, (2) Gift, or (3) Liquidate.
Sale: Selling a business can be a lengthy process, especially if the buyer is not an employee or family member. Determining a proper value for the company and going through various negotiations can take months or years. In positive economic climates, a business-owner could find himself or herself in an unexpected position to sell if there is an aggressive buyer with interest in the company. Absent potential buyers knocking down the door, an owner who wants to exit the business needs to assume that the process will take some time and will need to start the process in earnest at least a few years before he or she plans to stop working. Brokers can often help sell a business and have a wide array of resources and connections to potential buyers.
Gift: Sometimes an owner will want the company to stay in the family. In these cases, the owner has a number of options, including selling to the family member or utilizing a trust to transfer the ownership of the entity. If the family member does not have the money to purchase the business or the business is not generating enough cash flow to essentially finance the buyout of the exiting owner, the option of gifting could come into play. The two biggest drawbacks to gifting are that (1) the exiting owner does not get any cash for the portion of the company gifted away, and that (2) depending on the size of the company, the gift could be subject to gift tax. The gift tax exemption continues to increase (see below), but those exemptions could change based on the whims of Congress. Most times, unless an owner has significant wealth generated outside the business, he or she will not want to gift the entirety of the business, put perhaps gift portions over time and have a partial sale later.
Courtesy of www.thebalance.com
Liquidate: A liquidation is a common option for a retailer or other business with inventory. Absent a family member to take over the business or an interested buyer, an exiting owner may be left with no choice but to liquidate the company’s holdings. The downside to this plan is that the markup on the inventory is often not great in a liquidation, so there is less reward to liquidating than there is to selling.
For those business owners who want to exit their business in the next two years or next 40 years, there are important steps to take:
- Determine what you want in exiting the business: Is monetary reward for financial investment in the business most important? Is having the business become a legacy of the family (or continue a legacy) most important? Knowing what you want makes determining an exit strategy easier.
- Have a plan: Once goals have been established for the exit, coming up with a plan. In businesses with multiple owners, there is often a buy-sell agreement in place.
- Consult attorney and CPA: There are various legal and tax ramifications to transitioning a business, so in the process of establishing a plan, business advisors should be part of the planning process.
- Reevaluate the plan: The plan that is initially established may not be the best long-term plan as the business progresses. Perhaps a family member does not want to run the business. Perhaps the growth of the business makes previously unconsidered options more attractive. Continuing to consider necessary changes to the plan will allow for the best possible transition.
Take a look back at all installments in our series on Mistakes Small Business May Make:
- Confusing Knowing Trade with Knowing a Business
- Forgetting ‘Achievable’ When Setting SMART Goals for a Small Business
- Failure to Implement Proper Capitalization Planning & Equity Retention in Your Business
- Failing to Price or Buy Appropriately
- Ignoring GAAP or Tax Effects of Business Decisions
- Avoiding Difficult Decisions In Your Business
- Not Using Forecasts or Projections – Part A
- Not Using Forecasts or Projections – Part B