Exit Planning Options: What You Need to Know if You Want to Sell Your Business

Internal and External Exit Planning Options

Owners often believe that when the time comes for them to leave their businesses, they’ll simply sell them or pass them on and begin their next phase of life. But the reality is that exiting out of business ownership is a complex and long process, not a discrete event. When considering their options, owners typically focus on the financial considerations, often assuming that the higher the sales price, the more they will net – but that might not necessarily be the case – without proper planning 30% to 50% of the sale proceeds could be consumed by taxes and fees.

Thinking about selling to a third-party buyer?

That’s what many owners think they’ll do. However, less than one in five willing sellers are able to find a willing buyer and consummate a transaction.

Or, maybe you want to pass your business on to your children?

Less than one-third of family businesses survive the transition from first to second generation ownership.

Selling or transferring your business is anything but simple. But you can do it successfully with thoughtful, careful exit planning.

Internal and External Business Exit Options

There are two general categories of business exit options – internal and external. “Internal” refers to selling or giving the business to insiders, such as employees, managers, or family members. “External” refers to selling to an outsider, such as a competitor, customer, or investor. We’ll provide you with an overview of the most common types of external and internal exit strategies, their broad characteristics, and the types of businesses and owners best suited for each.

The exit planning process can provide a business owner with direction and a vision for his or her business, identify opportunities for growth, and determine areas that may need improvement. As a business owner, you should start thinking about your exit plan as early in the life of your business as possible and develop a strategy that can help you achieve your financial and personal goals…both short and long-term!

What You Need to Consider for Your Exit Plan

As a business owner who has put years of blood, sweat, and tears into your business, this may seem counterintuitive, but planning for a successful sale or transition is likely to be one of the most significant challenges you will face. It pays to get educated and evaluate your options as early as possible – years before you want to step away from your business.

Choosing the wrong approach could have unintended consequences for you, your family, your employees, and the company itself. As you weigh the various options, it is imperative that you understand that different transfer options have different transfer values, varying fees and taxes, as well as different personal and business implications. You’ll need to consider which exit strategies will satisfy both your financial (how much money you need) and non-financial (what is important to you) objectives.

Seeking Professional Guidance

Owners shouldn’t go it alone as both internal and external transitions can be far more complex and time-consuming than you may realize. Make sure to seek proper support as you start your journey. Advisors who specialize in business transition planning can help guide you through the process to develop a Business Ownership Transition Plan (BOTP). The more time you give yourself to plan your business exit, the more options you will have, which is the best position to be in as you plan your future and the future of your business.

External Exit Planning Strategies

Finding the right buyer is more difficult than you can imagine, but it’s only half of the battle. Consummating a deal is a long and arduous process as well.

External sales are usually funded by the buyer using both debt and equity capital. However, sellers are often required to provide seller financing for at least a portion of the selling price and receive payments over time. Some types of buyers want the sellers to stick around while others do not.

Third-party sales are typically transacted at “market value” or what the market dictates when you have a willing buyer and a willing seller but this can vary by type of buyer. Value is driven by the buyer’s perception of risk and reward-related to the acquisition target. Strategic buyers will pay the highest value since, by definition, they will realize immediate synergies (i.e., increased profits and a higher rate of return on their investment). Financial buyers will pay less based on their anticipated rate of return.

Understanding the selling process, what buyers and lenders are looking for, and how to position the business will improve your chances of having a successful external transfer. Check out the “Art of the Deal” chapter in our book Cashing Out of Your Business – Your Last Great Deal for a list of the “Top Ten Deal Killers” that you must avoid during the selling process.


PRIVATE EQUITY SALE / RECAPITALIZATION:

Financial buyers, such as private equity firms (PEFs) usually purchase a majority stake in the business, up to 80%, and allow current owners to keep a portion. Leveraging their capital, expertise, and relationships, buyers plan to increase value over three to five years, resell the business and lock in a large return for all shareholders.

The PEF generally wants owners to remain involved for a period of three to five years. This can be a good option for an owner who believes that a third party sale is the best option, but also wishes to remain involved with the business for a few more years.

Business Value: Financial market value

Funding Sources: Debt as well as equity capital

Owner Timeframe: Up to 5 years

Tax Implications: PEF sales/recapitalizations are stock transactions that are typically structured as asset sales in order to minimize taxes for the buyer. S Corporation sellers will pay ordinary income tax on a portion of the proceeds and capital gains on the rest. C corporation sellers will pay the highest tax at both corporate and personal levels.

Business and Owner Suitability:

  • Companies with more than $1M in annual EBITDA
  • Companies with strong growth or growth potential >20% annually
  • Owner who wants to retain some ownership and potentially get a second payday if the company sells again
  • Owner who is willing and able to work for someone else
  • Key employees and/or family members may not have the desire or ability to be owners

SALE OF 100% OF BUSINESS TO A THIRD PARTY:

This type of sale may be to a financial buyer who needs to keep the existing business structure or to a strategic buyer that can realize synergies (i.e., reduce operating expenses) and increase profits as a result of the acquisition.

The buyer may be an individual or another company and they may pay the highest sales price, but you may or may not realize the highest net proceeds. You may not be involved with your business for very long after the sale.

Business Value: Financial or synergistic market value

Funding Sources: Debt, equity, and/or seller financing

Owner Timeframe: 9-12 months

Tax Implications: Most third party sales are asset sales that are taxed at least partially at ordinary income tax rates. C corporations will pay tax at both corporate and personal levels.

Business and Owner Suitability:

  • Well-run businesses with solid financials and growth potential
  • Owner doesn’t have family members or key employees who are able and willing to run the business
  • Owner desires faster payout and shorter timeline for involvement

ADVISORS YOU WILL NEED
:

Selling your business to a third party can be a minefield for business owners if you don’t have the proper guidance in navigating the marketplace. This is a complex world of brokers, investment bankers, private equity groups, lenders, buyers, lawyers and due diligence. Getting prepared for a possible transaction and minimizing taxes and fees takes time, preparation, and the assistance of a skilled advisory team.

The advisors you should select for an external sale include:

  • Business transition advisor
  • CPA with experience in tax planning for business sales
  • Transaction attorney
  • Business intermediary (business broker or investment banker)
  • Personal wealth advisor

THE PROS AND CONS OF EXTERNAL TRANSFERS:

Pros:

  • May be higher gross sales price than internal sale
  • Owner may be able to walk away from the business
  • Owner likely to receive most of the money upfront

Cons:

  • Higher taxes and fees
  • May take significant period of time to make business attractive to buyers
  • Ability to consummate a transaction is dependent on economic conditions and the market for business sales
  • Owner has no control over the future of the business, including location and employee security; can be disruptive
  • Complex and stressful due diligence process and negotiations
  • Owner may experience seller’s remorse
  • It can be difficult to find a buyer and close the deal

Internal Exit Planning Strategies

Internal transfers generally occur at a lower gross price than an external sale, but may produce a greater net sale price due to tax and fee minimization.

These sales are typically funded through business profits or in the case of a leveraged buy-out, third party financing. Generally, in an internal sale, the successors do not have much, if any, capital to invest and the seller does not receive a large amount of the sale proceeds up front. Owners may keep control and minimize taxes if they sell their ownership stake slowly over time. The values normally associated with these types of transfers are fair market or investment value if the business is profitable enough.

There is very little business disruption and employee morale is more likely to be unaffected. Owners can stay longer than with an external sale and can continue to collect salary and perks while they groom successors to run the business.


FAMILY TRANSFER:

Owners transfer the ownership of their businesses to their children or other family members by sell­ing and/or gifting shares.

Business Value: Fair market value

Funding Sources: Business profits, bank debt

Owner Timeframe: Whatever they wish, but 5 to 10 years is not unusual

Tax Implications: Can be structured to minimize taxes by selling shares and securing capital gains treatment

Business and Owner Suitability:

  • Current owner wants the option to stay in control longer
  • Family members who are ready to be owners and can be groomed to operate business
  • Current owner may have estate tax exposure that is increasing as company grows
  • Business that is profitable and growing enough to support all generations
  • Business may or may not be marketable to outside buyers

MANAGEMENT TRANSFER:

Owners reward loyal employees by selling the business to them. This may be a one-time event or a gradual sale over time.

Business Value: Fair market or investment value

Funding Sources: Business profits, bank debt, manager capital

Owner Timeframe: Negotiable but could be up to 5 to 10 years

Tax Implications: Can be structured to minimize taxes by selling shares and securing capital gains treatment

Business and Owner Suitability:

  • Current owner wants the option to stay in control longer
  • Key employees who think like owners and can be groomed to operate the business
  • Business is profitable enough to fund buyout or borrow funds if employees do not have capital
  • Business may or may not be marketable to outside buyers

EMPLOYEE STOCK OWNERSHIP PLAN (ESOP):

An ESOP is a qualified retirement plan that is created when an owner sells all or a portion of his/her business shares to a trust on behalf of all of the company’s employees. Employees earn shares annually that are converted to cash when they retire. Owners continue to maintain control over and run the com­pany as long as they desire.

Business Value: Fair market value

Funding Sources: Business profits, bank debt

Owner Timeframe: 5 to 10 years

Tax Implications: Can be structured to minimize taxes by selling shares and securing capital gains treatment. S Corporation ESOPs do not pay income taxes to the extent that the ESOP trust owns the shares. C Corporation owners may defer paying tax indefinitely by investing the proceeds in Qualified Replacement Property.

Business and Owner Suitability:

  • Current owner wants the option to stay in control longer
  • Culture conducive to having all employees as owners
  • Company has minimum of 20 employees, $3M of business value, and $500K of annual cash flow

ADVISORS YOU WILL NEED:

An internal sale must be carefully negotiated and structured to minimize taxes and fees and will require the buyer(s) to be included in the process over the course of many meetings, until an agreement is reached. For an internal sale, you will most likely need the following advisors:

  • Business transition advisor
  • CPA with experience in tax planning for business sales
  • Corporate or transaction attorney
  • Personal wealth advisor

THE PROS AND CONS OF INTERNAL TRANSFERS:

Pros:

  • The successors understand the business
  • Sale can be structured to minimize both transaction as well as estate taxes and fees
  • Little disruption to business continuity
  • Owner can remain active with the business during and after the sale
  • Ownership can serve as a reward for key employees
  • Provides a path to multi-generational wealth building
  • Owner can maintain control during the transition period
  • Allows for the successors to be mentored by the owner during the transition

Cons:

  • The transition may require owner to remain involved with the business
  • Owner’s proceeds will likely be dependent on the future success of the business
  • Structure may require owner to receive proceeds over a period of time
  • Complex personal dynamics with multiple family members or employees can create challenges
  • Successors may require additional mentoring and or coaching
  • Third-party debt or seller buy out can inhibit the company’s growth

Determining Which Strategy Is Right for You

Choosing the most suitable ownership transition strategy for your business is not an easy decision to make. While every business transfer is unique, there are pros and cons to each type and it’s important to assess the different options and figure out which one will accomplish your financial as well as non-financial goals.

Engaging in the Business Ownership Transition Planning process, guided by experienced advisors, will help you align your objectives with the best transfer options available and provide a comprehensive roadmap to a successful outcome. Having an effective BOTP in place well in advance of a transition will improve your chances of securing the future of your business and creating a positive experience for you, your family, and your employees.

Building Your Business Transition Team

Whether you are planning an internal or an external transfer, these transactions require the expertise of professionals who can design plans to meet your overall goals. And, if you have multiple shareholders or are considering choosing a successor from inside your family, you may find it to be particularly helpful to bring in an outside advisor who can provide impartial and objective guidance. Through their experience, training, and creative planning, transition mentors can identify tax- and fee-saving structures, which may not be considered otherwise.

Some of the activities your advisory team will assist you with include:

  • An assessment of your personal financial needs and objectives
  • Choosing the right transition option for you and your business
  • Business valuation
  • Business performance improvement to maximize company value
  • Pre-deal preparation and diligence
  • Finding the right buyer
  • Maximizing your deal price and terms
  • Personal financial and estate planning
  • Addressing potential deal killers in advance

Selling or transferring the ownership of your business is often a once-in-a-lifetime event. As a business owner, you should be fully informed about all of your options and aware of challenges you are likely to face along the way. A qualified exit planning team can provide you with the guidance and assistance you need to help protect one of your largest assets and improve your financial future.

Ready to start your exit planning process? Click here to access our free membership resources and make your last deal your best one yet!

 

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