Which Exit Strategy Is Right for You?
There are a number of methods for transferring your business when the time comes. But you have to start planning early.
By: Chia-Li Chien | Published 05/16/2010
This is the second of three excerpts from Show Me the Money by Chia-Li Chien.
Have you ever received a flier from a local real estate company showing recent buying and selling transactions in your neighborhood? It can be handy and serve to give you a clear idea of a comparable market value for your home. It will also give you some idea about how attractive your neighborhood is to buyers. As a matter of fact, almost any Realtor will tell you that if you ever consider selling, she'll do a comparables search first to let you know how much your home is worth based on the recent selling prices of houses similar to yours in your neighborhood.
You should be aware, however, that a privately held business market transaction is quite a bit different than a residential real estate sale. To begin with, there are many ways to construct the transaction. For example, you may receive a call from a business broker or investment banker with the news that he or she has buyers ready to buy, but can't find a qualifying company ready to sell, or vice versa. (This particular situation is considered a third-party transfer or external transfer.)
(According to the Small Business Administration, one-third of all businesses will sell to a third party, one-third will transfer within their own firm, and one-third simply close the door.)
So which type of exit is best for you? Most business owners focus on growing their company revenue and overall operations. The majority of business owners really don't even think about their exit--much less about which exit strategy is right for them.
According to the Center for Women's Business Research, 39.3 percent of women business owners will sell to a third party, 21.3 percent will pass the business on to family members, 3.5 percent will simply close the business and 17.3 percent have no plan. And a majority of business owners don't want to think about an exit. Why? Because 78.8 percent believe that going into "retirement" is the trigger point for when they need to think about their exit. Don't you think it's a bit too late at that point? Things take time, and you can count on needing about three to seven years to strategically increase the value of your business, regardless of who the buyer is.
Again, unless you plan early and have an overall strategy in place, each of the following transfer methods will be only a tactical exercise. Please keep in mind that, depending on which method you choose, the market value of your business will vary.
In general, you either transfer your business internally or externally. In some cases, businesses can structure so that they have a combination of internal and external transfers to achieve ultimate retirement and estate planning and tax efficiency. But before we jump into each method, ask yourself: In a perfect world, how do you want to leave your business? Who's the best candidate to continue your legacy? Can the sales proceeds support your next journey?
Going back to our residential real estate example, you only go to a Realtor if you're considering selling to someone you don't know. It is up to the buyer and not the Realtor to match your asking price. The outside buyers are not party to the information of whether you're making a profit from the transaction or not.
However, if, in fact, you already know to whom you want to sell your house, you can simply find an attorney and have the transaction done without a Realtor. That is the difference between internal transfer and external transfer.
Keep in mind that you will need a different team of advisors depending on the type of transaction--internal or external. It is not a saving factor, but more of an effectiveness factor. You don't want to make any mistakes in these transactions. (One owner told me that she did not have the right team for her business transfer to her partners, and she ended up fighting in tax court for many years after the transaction.)
In general, any transfer technique has three key components that the seller defines. These are:
1. How much control (voting vs. nonvoting)
2. How much income
3. How much equity (ownership of the company) the seller wants to have
All financial-assets transactions are driven by these three key components. Based on a seller's objectives, one can design combinations of these methods to accomplish the desired end result. The ultimate goal is to move the seller's position in control, income and equity to the mile marker where he or she wants to be.
Internal transfer--This type of transaction typically happens within the business. It means transferring to employees, families, co-owners or--my favorite--a charity. The financing of an internal transfer can potentially come from your bank or you, as the owner. Professional advisors such as an attorney, CPA, certified financial planner or your banker (if you're not personally financing the deal) can help you. Ideally, you would have an exit advisor who has been through this process with other business owners many times.
External transfer--Most people refer to this as a third-party or non-related-party sale. Most of the time, business brokers and investment bankers are heavily involved. Business brokers typically deal with businesses with a market value of less than $5 million, while investment bankers handle values greater than $5 million. (However, some business brokers can handle more than $5 million in value, and some business brokers only work with franchised businesses.) But they are all called transaction intermediaries.
You will find that some business brokers might even finance your deal. Investment bankers, in most cases, help raise the capital for the deal. Therefore, more credentials are required to be an investment banker. Again, you'll need to assemble a team of advisors to help you through this transaction--don't depend only on intermediaries.
The right advisors
Businesses owners should assemble a transition team including an attorney, CPA, certified financial planner, intermediaries or bankers, and others as necessary. Beware: Not all advisors are properly trained or experienced for your needs. Check their background and experience, and ask if they are credentialed from one of the following:
Business Enterprise Institute Inc.--Primarily focusing on transactions one year away from sale. Provides training to advisors along with software training to generate an exit plan for clients.
Exit Planning Institute--Primarily focusing on training advisors to develop exit strategies. Uses the MidasNation private capital market textbook as one of the teaching materials.
MidasNation or Midas Institute--Primarily focusing on taking the company to the next level and maximizing its value through various strategic and tactical solutions. Considered a premier listing and financing network. Ideal for businesses three to five years away from an exit transaction.
A combination of external and internal
Gigi has a high-tech medical device R&D firm and sells the technology to major university medical schools. She ultimately wants to sell her business to a third party. But to remain efficient in estate, tax and retirement planning, the recommendation is to transfer her company (she has eight different business entities) into intentionally defective grantor trusts several years prior to selling. Through an IDGT, her two children, who are not in the business, will own a portion of the business. Some key employees are also interested in the business; therefore, a small portion of the equity will be a management buyout. Upon the third-party sale transaction, Gigi, her two children and her key employees all benefit. Gigi will stay on for the next three years as company CEO. Gigi also reduced some capital gains taxes in the process.
You, as a business owner, have the flexibility of using a number of methods to transfer your business when the time comes. It is all driven by your objectives. But you can only do so by planning early, not by waiting for trigger events such as the loss of a major customer, a hostile takeover, or your key employees becoming disabled or passing away unexpectedly. Protect your business and preserve the value as much as possible from unforeseen trigger events by planning early. We recommend you begin planning a minimum three to five years prior to the opportune time.
Triple the current benchmark value
When you prepare to create an exit strategy, don't think of it as just a project plan to help you sell or transfer. With the right team of advisors and mentors, you should consider this an opportunity to strategically triple, quadruple or even quintuple your current benchmark value. If that is not your objective, then an exit strategy is a simple project plan. Don't waste your time on just a plan. Create a personal financial strategy that will address your estate, current taxes, retirement and investments. This will help preserve your assets and ensure an ultimately smooth transfer to your loved ones. During the planning process, you might hear that the projected sales proceeds will not support your current lifestyle. Keep your options open as you consider all factors that directly impact your exit strategy method.
According to the study conducted by Center for Women's Business Research, women business owners tend to "take care of" people such as employees and children. As you can see in Gigi's example above, you can "take care" of your people. But the key is to plan early and explore options that are best for you and those you care about. You must make sure you are taking care of you first, before others.
Read the previous excerpt: Buy Low, Sell High
Chia-Li Chien, CFP®, CRPC, PMP; helps women entrepreneurs to convert their business into meaningful personal wealth. She is the author of Show Me The Money and columnist for WomenEntrepreneur.com & Fox Business online. She is available for consulting, speaking engagements and workshops. She can be reached at www.chialichien.com or firstname.lastname@example.org.
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