According to a national survey of high-net-worth business owners1, fully two-thirds lack a documented exit strategy or succession plan. Among older business owners (those over 50), the figure remains as high as 64 percent. What does this mean for the future of their companies? Or for their personal financial plans? Essentially, it’s time to get to work…
The following outline looks at five common business exit strategies—listing pros, cons and other key facts. Review them to start your exit strategy research and planning process ASAP.
While you’re at it, take five minutes to complete the 2016 Michigan Business Owner’s Exit Strategy Survey. You’ll automatically receive the complete survey report, which will help you benchmark your plans and challenges against local peers. You’ll also be entered to win a free business valuation (worth $15K-$20K) from Angle Advisors, and other valuable prizes.
1. Management Buyout (MBO)
A management buyout (MBO) happens when an executive team combines its resources to acquire a portion (or all) of the business they manage. In some cases, management buyers put up company assets to secure financing for the purchase. This is known as a Leveraged Management Buyout (LMBO).
Pros: An MBO or LMBO provides immediate personal liquidity for business owners and shareholders (versus an IPO, for example). Meanwhile, MBOs may help owners avoid much of legwork involved in shopping for outside buyers, performing due diligence, and managing the transition. Further, by ceding your business to a leadership team that’s already well established, you may feel more confident about its long-term outlook. Senior team members who have helped you over the years will reap the rewards of their hard work.
Cons: All together, conducting a business valuation and securing financing can take months or years. Management team members will need a solid business plan to account for debt repayment; plans may include cost-cutting measures or aggressive growth initiatives.
2. Outside Sale
Selling to someone outside your company can make sense for several reasons. But it’s not a process that happens overnight. Waiting until you need to retire or sell typically limits your return potential.
Pros: Again, the opportunity to cash out immediately (versus an IPO) is a big upside. You can negotiate for your ideal sale terms and choose your ideal buyer. Also, the legwork involved in prepping for a sale inevitably makes your company stronger. Ultimately, you may find you have more options than you realize.
Cons: Unlike with an MBO, you’ll have little say over what happens to your employees, your business’ place in the local community, or the overall business direction. In advance of the sale, you’ll need to invest (years of) time and energy making your business as attractive as possible. You’ll want to demonstrate a strong value proposition and a solid sales/performance history, which may mean assuming a more profit-driven agenda. Finally, if word of imminent sale gets out, you may risk losing major customers.
3. Employee Stock Ownership Plan (ESOP)
According to the American Bar Association2, “an ESOP is a type of qualified retirement plan similar to a profit-sharing plan, except that an ESOP is required by statute to invest primarily in shares of stock of the ESOP sponsor… Although an ESOP is one of several alternatives that will enable an owner to gain liquidity and transition ownership, ESOP strategies afford several unique advantages.”
Pros: There are a variety of tax benefits associated with an ESOP that can be leveraged by individual business owners (capital gains taxes deferred) and their companies (lower tax rates). When considering how you will invest sale proceeds, the tax management upsides are definitely worth a second look. Above all, ESOPs offer a way to reward dedicated employees.
Cons: The transaction valuation is typically lower (fair market value versus strategic value), and the ongoing administrative burdens may not appeal to all organizations. What’s more, if your company has amassed significant debt and/or if employee turnover is high, an ESOP probably isn’t the best route.
4. Initial Public Offering (IPO)
IPOs are certainly less common than they were in the days before the dot.com bubble burst, but that doesn’t mean they’re less profitable. Are you primed to go public?
Pros: In the right market, an IPO strategy can deliver unparalleled ROI in the form of long-term capital. The financial gains to be realized are potentially far beyond that of a company sale or liquidation, which is one reason why so many entrepreneurs aspire to an initial public offering.
Cons: If immediate liquidity is a priority, keep in mind you won’t be able to monetize your shares for six months or more, as you will likely be subject to a share lock-up agreement. You will also need to address the costly, complex requirements of going public—namely, Sarbanes-Oxley standards. Major undertakings include independent board setup, auditing arrangements, system upgrades, and an overhaul of all your reporting mechanisms. Finally, market conditions aren’t always ideal for going public. There’s an element of timing involved that means you cannot necessarily pre-plan your timeline according to your ideal retirement age.
5. Transfer Ownership to Family
Selling or transferring company ownership to your heirs is often the simplest, most straightforward option available. And yet 84 percent of high-net-worth owners don’t expect their children to continue the business3. Does an in-family transfer make sense for you?
Pros: Typically this approach creates less business disruption, and is easier on employees. If your children have grown up in and around your workplace, they probably have an aptitude for the business; they can enjoy a stable, fulfilling career and continue your legacy.
Cons: The potential for major estate tax consequences means the transfer should be carefully planned and reviewed with the help of a financial professional. Transferring portions of the business early (when it is worth less), via living trust, may allow heirs to avoid hefty gift tax. You might also consider transferring the business to a charitable remainder trust.
How does your exit strategy compare to other business owners’ plans? Get the full report. Complete our five-minute survey today!