Each exit strategy depends on multiple factors
Ask a business owner who has spent years building a company, "What’s the hardest part about selling it?" The answer, in most cases, won't be just about the selling price. In my experience, most founders have multiple concerns, which include ensuring a productive succession that takes care of family members, employees and customers. Retirement security, tax planning as well as emotional attachment to the life work of the business owner also factor into the decision.
Not surprisingly, there are many approaches to selling a small business. In general, they fall into three main categories: liquidation, outright sale and going to public markets for an initial public offering (IPO).
The suitability of each exit strategy depends not only on the owner’s personal disposition but the nature of the business, starting with its size and financial condition. It's also important to understand the practical differences in selling assets that are tangible (plant and equipment) versus those that are marketable (intellectual property) or represent the accumulated knowledge and experience of the owner and key employees.
The easiest way to sell a business is simply to liquidate the assets. Of course, you need to own marketable property and equipment to make this worthwhile. The only planning required is to inventory the property and estimate the market value. Presumably, the amount you’ll receive, plus savings and investments, will be sufficient to sustain you through retirement.
Liquidation over time is a strategy that allows you to access the capital retained within the business over a period of years. You increase your salary and annual bonuses at the same time as you curtail normal spending on marketing or adding new infrastructure, equipment and staff. This allows you to continuing paying for insurance and the cost of automobiles, phones and computers as legitimate business expenses. You can liquidate any tangible property when the company's revenue no longer justifies keeping the doors open.
Liquidation strategies work well if there's no obvious successor, or if the business's chief asset is the owner's knowledge and skill, which can't be transferred to a buyer. That said, many businesses are viable after the founder passes the baton. Below I describe selling strategies designed to capture the fair value of your company's future earnings.
Selling your business to a family member, current management team or rank-and-file employees can be a satisfying transition, because you get to see your company continue under the reins of people you know and trust. That's also a win for your customers, who benefit from continuity.
An installment sale is a widely used strategy for these situations. However, it requires planning in advance. This approach may allow you to stay on in an emeritus role for a designated number of years. You receive a down payment at the outset of the deal. After that, you receive a percentage of the profits during the term of your engagement.
This structure creates a positive alignment of interests and a smooth transition for everyone involved. If the buyers don’t have ready cash for the down payment, it’s usually possible to get financing from the Small Business Administration (SBA) [i]. Alternatively, when the sale is to a family member, you can help with the down payment and reduce the tax burden on the transfer by giving company stock to your successor annually. It’s a smart estate-planning strategy, but it requires that you begin well in advance of the sale.
An employee stock ownership plan (ESOP) sale operates on the same principle of tax-sheltered equity. An ESOP is a benefit program that allows employees to gain equity in your company via salary deferral and, possibly, an employer match. Again, it helps to set up the program well in advance of your retirement so the ESOP will have sufficient equity to buy the company.
If not, a leveraged ESOP can close the gap. In this strategy, employee contributions pay off a bank loan to the ESOP over time. In this scenario, employees gradually gain ownership of the company in a smooth transition. As part of the transaction, you may be able to implement what's called a 1042 Qualified Replacement Property (QRP) strategy. (This is a complex tax shelter that I'll explain in detail in a future article.) Bottom line: It provides a stream of current income and also defers the capital gains liability until after you pass away.
An outright sale to a competitor offers the biggest potential payout. Businesses in your niche are in the best position to understand the value of your enterprise. Buying your company could allow them to enter a new geographic market, add complementary products or services, or achieve economies of scale. Ideally, there could be more than one suitor, and a bidding war could work in your favor. For tax purposes, selling your company is likely a long-term capital gain, which is more favorable treatment than liquidated assets receive.
Job loss is the major downside to selling to a competitor. By definition, there are likely to be redundant positions that get eliminated. Owners with a strong attachment to their workers are better off exploring a management buyout or an ESOP sale as described above.
3. Initial public offering
An initial public offering (IPO) is every entrepreneur’s grand and glorious dream. Your company could be the next Amazon or Google! If you think that's the case, then you and your financial advisor should meet with accountants and attorneys who specialize in mergers and acquisitions (M&A) in your industry.
In my experience, only a tiny percentage of family businesses are able to exit via an IPO. Revenues need to be at least $50 million per year and, more commonly $100 million, before your company is in the ballpark. After that, you will need experts who can tell you, with brutal honesty, how your operations and financials appear from a Wall Street perspective: Are revenues visible and poised to grow? Is your balance sheet pristine? Do you have a world-class team in place? Are you ready to expose every aspect of your business to public scrutiny and comply with a raft of complex regulations such as Sarbanes-Oxley?
If this sounds like the challenge you've been waiting for … go for it! Just remember, in most cases, IPOs are not a suitable retirement funding strategy.
Making your decision
In practice, you'll find that the choice of how to sell your business will develop organically as you consult with various stakeholders, including family members, partners and key employees. Conversations with your financial advisor, attorney and accountant will identify options for you to consider. And they may point you to specialists in their fields, when complex legal and tax considerations require it.
In future articles, I'll go into more detail about some of the topics that were just touched on here: estate planning, tax strategies, assembling the right team to help you and perhaps the most important topic of all, preparing yourself emotionally to sell your business.