Can You Afford To Exit Your Business? — 4 Steps To Peace Of Mind… Or A Reality Check

John R. McAlister

By John R. McAlister & Brad Standridge, VPs with The Beringer Group

Owning and building a successful business comes with a price tag, often at the cost of long hours and sleepless nights worrying about employees, cash flows, government regulations, potential lawsuits, personal guarantees, and so on. But the rewards…financial security, respect, influence, and lifestyle are worth the price. Your family business is not just an enterprise; it’s part of your identity and plays a major role in every important decision affecting your family, employees, and community.

However, the reality is that every business owner has an expiration date when they will inevitably step away from the business. There are many options for a grand exit, including transferring the business to family, management, employees, a competitor, or a leveraged recapitalization, to name a few. Each option has unique characteristics that need to be understood well before choosing an exit path that best aligns with your business, financial, and family objectives for life beyond the business. Learning “on the job” may limit the options available and could potentially reveal that exiting your business on your own terms is financially unrealistic. The following four steps are a starting point for evaluating options that best meet your financial goals.

Step I – Define Your Objectives

Start by crystalizing your objectives. Establish an ideal timeframe and identify a “must exit” date. Next, think about how life may change once you step back or away from the business. Discuss these changes and future aspirations with family to assess their importance. Determine the after-tax monthly or annual income you will need to sustain the lifestyle you desire after you exit.

Also consider the legacy you wish to leave behind. Do you expect your business to uphold the same values and reputation it maintained under your leadership? Do you want your family involved? Is preserving the family business for the next generation important, or do you wish to leave wealth to your children? How do you feel about your employees, stakeholders, and the community in your decision-making process? Answering these questions can help you and your family create an exit plan that works toward your post-exit goals.

Brad Standridge

Step II – Financial Readiness

Take a look at your personal financial statement. Determine what income will be produced from your non-business assets. Model projected annual income from real estate holdings, retirement and brokerage accounts, social security, and other potential income sources. Remember to account for taxes and inflation in your calculations. How do the projected cash flows compare to the income needs previously defined to maintain your desired lifestyle? If there is a shortfall, how much will you rely on income from the business or proceeds from its sale to fill the gap?

Now that you understand all your income from outside of the business and what you need from the business, you should have the benchmark necessary to keep your objectives in line with your exit planning expectations.

Step III – Valuing Your Business

There are a few questions you need to ask yourself. Is your company worth the same amount without you? How does it operate when you are not around? Can you take a couple of weeks off without everything falling apart? And lastly, put yourself in the shoes of a possible buyer. Would you buy your business if you were in the market for an acquisition? A buyer with a fresh set of eyes will spot most, if not all, the potential issues in short order and will discount that risk into their purchase price. They will also sense a great opportunity and pay a premium to purchase a thriving organization with strong successor management. The company’s ability to continue to operate successfully in your absence is a critical component of valuation.

The valuation for your enterprise will also vary greatly, depending on whether it is an internal sale to family, ESOP, third-party buyer, or a financial buyer. Generally, the highest valuation can be expected in a full sale of the company to a strategic buyer, followed by a financial buyer, ESOP, and management buyout. An internal sale to family (or trust) has flexibility on the valuation, but financing mechanisms and the impact on the business must be considered carefully. Income, capital gains, and wealth transfer taxes should also be closely examined to arrive at a realistic expectation of net proceeds. The type and structure of each transaction can produce dramatically different net results.

Step IV – Run The Numbers — Again

Once you have determined the expected net proceeds or installment payments from the various exit options, calculate the income you can expect to generate from the liquidity. Many business owners find it challenging to reproduce the returns they are accustomed to outside the business. The key consideration is whether the business or its sale, combined with your non-business assets, will generate sufficient income to sustain your desired lifestyle and meet the objectives you identified in Step 1. If there is a shortfall, early detection is crucial. Recognizing a gap early allows you time to develop a strategic plan to reach your objectives.

If you are going to Exit on “Your Terms,” here is what you do….

You know the saying, “Measure twice, cut once.” If you are cutting expensive wood, you may want to measure it three times because a mistake can be costly. The same holds true with your numbers for your exit. You will only get one shot to get this right.

For now, you have at least identified a target. Finding the right path to an exit from your company will take great patience and persistence. The longer you have to plan, the more likely you are to achieve the results you desire.

John R. McAlister and Brad Standridge are vice presidents with The Beringer Group, which since 1979 has guided over 2,200 family-owned companies through the complexities of transferring the business to the next generation or selling the company in the future. For more information, call 813-793-6780 or go to www.theberingergroup.com.