Many people say a business plan is a key element for any start-up business. But in many cases, not just an operating plan but a business exit strategy needs to be considered upfront. An exit objective and strategy may affect the business plan and may affect the best operational model for running a business. It’s never too early in the lifecycle of a business to begin thinking about an exit strategy.
An exit strategy is especially important at start-up in these situations:
When the growth cycle of your business may require a large infusion of capital at a future point and you don’t want to put money at risk.
Going to market with revolutionary products takes a tremendous about of capital. So does building many other types of businesses like software companies or service companies. Businesses with slow cash flow also demand high levels of capital. Often it makes sense to build these businesses to a certain level and sell them rather than lower profits through borrowing or diluting ownership by seeking investors needed to secure capital.
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When you plan or hope to get out of the business at a certain age or after some number of years.
If you are running a small business and hope to retire 3 years from now, it might make sense to sell now. Many purchases will want you to stay to transition from some number of years. If an employee buyout is a plan, you might need to collect installment payments over several years before transitioning the business as few employees have the cash needed upfront to buy you out.
Downturns in the market can greatly affect your business. Your plan needs to realize you might be financially better off selling your business now and staying two years than gambling on market conditions two years from now.
When there may be tax implications of not exiting the business at the right time
Some individuals who are planning to immediately sell their business may be regretting they did not do it last year. Tax law changes currently being discussed could end up costing entrepreneur’s a lot of money as income thresholds might cause some business gains to be taxed as ordinary income instead of as capital gains.
An installment sale might provide more favorable tax treatment in a divestiture. An installment sale is a sale of property where you’ll receive at least one payment after the tax year in which the sale occurs. If you need the money from the sale of your business in 2025, you might want to sell in 2022 and save money on taxes through a 3-year installment sale. This requires advance tax planning.
When multiple parties are involved in operating a business that is not liquid there needs to be an agreed exit plan or point
If your business partner gets divorced, you may need to be prepared to buy out 25% of your business. Do you have the cash to do that, or are you about to begin a court-ordered fire-sale of your business? Will the court order a sale of your business if your partner dies? Have an exit plan and rules dictating what happens in these circumstances.
At what other points might an exit strategy really matter
When you have achieved your financial objective with the business
You need to be prepared for this day and positioned to capitalize on it when it arrives
When further investments in growth will not yield a desired level of return.
Sometimes a business reaches a point where investing additional time and money is a business that will yield only modest returns. Or the value in investing outside of the business is greater. At this point, the business owner has a financial incentive not to further invest in operations and this is generally a good time to sell.
When earnings from a sale of the business and future investments exceed what you might get through continued operations.
If your business is yielding a 4% return on capital and someone offers you the right valuation you might actually make more by divesting and investing than by continued operation.
When you have achieved your long-term financial goals with the business
If your goal was to retire when your business was worth some number, and you are there, it’s too late to start thinking about getting out. The process of preparing to sell needs to start sooner. Securing multiple bidders requires time and preparation and is a key to receiving maximum value for your business.
When you desire to extract accumulated value from the business.
There is always a risk of loss of underlying value through continued operations. A declining economy, loss of a major client, new competitors, loss of key personnel, any number of factors can lower the value of your business almost overnight. In many cases, selling is the only way for an owner to access the value they have accumulated in their business.
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When the business is worth more to someone else than it is to you.
Sometimes a buyer comes along that can get tremendous value from your business because it will provide economies of scale. This might be because they can lower SG&A expenses as a percentage of sales, it might be because of an opportunity to eliminate redundancies, or there might be an opportunity to drive additional sales through an expanded distribution channel. Regardless of the reason, when this happens selling usually results in significantly more earning that could be achieved through organic growth.
Unquestionably owners who do not have an exit strategy can lose business value and have a less favorable outcome if they are forced to exit because of illness, death, disability, disputes, family circumstance, or any other emergency circumstance. Such an exit may be financially less desirable and almost certainly will lead to a less favorable situation for employees and minority shareholders.
Few business owners divest at a point of maximum value. Owners are most often focused on selling, growing revenue, building profits, adding new products or services. Few are thinking about a plan to get out. In order to successfully exit, a business owner must focus on building “Salable Value.” The salable value may be affected by things other than revenue itself like long-term contracts, margin, trademarks, copyrights, the strength of the management team, competitive advantages, and other factors. So entrepreneurs need to think about building up these elements, not just building revenue.
Building salable value, thinking in advance about exit timing, and having an exit strategy is important from the very beginning if an entrepreneur wishes to receive maximum value for their work efforts.