Planning Ahead For Your Business Exit
For many business owners, the sale of their company is the culmination of a lifetime of work; such an event will occur only once in their life — with only one chance to get it right. Given that the circumstances for a sale often results from unpredictable events such as ill health or market fluctuations, you need to prepare for the event of a business sale well in advance. Being well-prepared can reduce the time it takes to complete a transaction and improve your take home payout from the proceeds of the sale. This article is a guide to planning ahead for the time when you decide to exit your business. For the purposes of this guide, exiting is defined as selling your business to another company or individual; IPOs are beyond the scope of this article.
Entrepreneurs can have a wide variety of motivations for exiting their business, ranging from retirement to burnout. Whatever the reason for selling, business owners should plan ahead by implementing an appropriate corporate structure, keeping good financial records, as well as maintaining their reputation locally and in the business community as a whole. Buyers will appreciate a current business plan that contains revenue projections and a detailed analysis of your market sector. A sound management structure that enable you to keep senior management out of the day-to-day business will not only create efficiency while you still own the business, it will also help demonstrate a credible succession plan in the event of a sale. As part of their planning, entrepreneurs should also familiarize themselves with the key aspects of the mechanics of a business sale, particularly due diligence so that focus on those aspects of their business that are likely to face scrutiny at the time of a sale.
Timing the Exit
A key part of planning ahead for your exit is considering the circumstances under which you might consider selling. Often, these circumstances will determine your negotiating strategy with potential buyers. A business owner who is exiting due to retirement is likely to put a high value on financial security, minimising risk by taking the time to pick out the perfect buyer from the list of offers. By contrast, an entrepreneur who wants to use the proceeds to start a new business might be more interested in exiting as soon as possible. Sometimes you may have to exit for reasons that are not entirely under your control.
Possible reasons for exiting include:
Market uncertainty
Regulatory changes, economic crises and disruptive competitors can lead to uncertainty about future market developments. Rather than lose their investment, more conservative entrepreneurs can be tempted to sell their business while they are still ahead.
Lifestyle change
This is arguably the easiest of the reasons for which to plan in advance. Changes might include desire to start a family, dedicating time to a new hobby, or retirement.
Boredom with routine
Given that many entrepreneurs start their own company to avoid the routine of a 9 to 5 job, transitioning from a startup to an established business can sometimes lead to feelings of restlessness. The entrepreneurial personality generally prefers personal growth and new challenges over mundane tasks such as revenue optimization and creating a company handbook. Over prolonged periods of time, the financial uncertainty associated with entrepreneurship can lead to stress, depression, and burnout.
Illness or exhaustion
The fact that illness can strike at any moment is perhaps the best reason to think ahead about an exit strategy.
Business failure
If continued operations are likely to erode your net worth, it might be a good idea to exit before you run out of money altogether.
For more information about reasons for selling, please visit our companion article to this piece on Reasons and Strategies for Business Exit.
The key point to note is that you are not always able to time your exit perfectly. You may be confronted with one of the above situations which will require you to consider an exit. Instead of planning your exit strategy at the last minute, it is a better idea to have your “war plan” ready and simply activate it when the right moment arrives. Another reason for having such a plan in place in advance is the fact that a good exit strategy may require you to put structures in place that require time and cannot be done in a hurry.
Corporate Structure
This is an area that is often neglected by most entrepreneurs. Often they incorporate their firm because they have a promising new client and wants to know about their company. The founders rush to incorporate their company and the corporate structure is decided quickly. When it is time to sell the business, the founders may realize that some of the corporate structure decisions they made years ago, are turning out to be quite expensive for them. Therefore, it is important to review your corporate structure from the perspective of an exit and evaluate if it will meet your objectives. Some of the questions you should ask are the following:
Jurisdiction
Is your business incorporated in a jurisdiction that will be most advantageous to you at the time of a sale. Jurisdictions differ in many aspects; most notably the taxes they impose at the time of the sale.
Control
If you plan to transition control of your business to your family, is the corporate structure conducive to such an objective. Through different share classes, you can maintain control over your business even if you do not control the full equity.
Tax Efficiency
There are several methods for you to take profits out of your company (as salary, as dividend, as director’s fees, etc.) These methods have different tax implications in different jurisdictions. You should align your corporate structure with the the method that you plan to use. For instance, if you plan to take some profits as director’s fees then you must be appointed a director of the business.
Plan the Management Transition
Employee retention
Identify those employees who are key to your business. Typically, these will include senior managers, key salespeople and employees with specialised knowledge, such as core engineers. Sincesuccessful retention of these employees makes your business that much more of attractive to a potential buyer, you should implement contractual arrangements that ensure that these key employees will stay with the business for some time in the future. Some possible ways of doing so are:
Grant equity to key employees that vests over time.
Enter into employment agreements for a defined future period.
Require a non-complete clause that prevents the employees from competing with your business for a set period after they leave the business.
Grant bonuses that are paid over the following year but vanish if the employee departs.
Provide a clear career growth path to the employees that is certain and achievable.
Management succession
If you are acting as the CEO of the business, to what extent are you critical to day-to-day business operations? As your business grows, you should be delegating your job functions to key managers to ensure that you yourself can work on the business, as opposed to in it. The ideal founder is the one who is able to delegate his job away to the point where (s)he is not required to run it anymore. On a regular basis, evaluate the performance of the managers who report to you and consider whether they could fill your shoes in the event of a sale. If this is not the case, invest resources into training them, or replace them altogether. For a successful exit, it is very important that you must have a succession plan in place for yourself.
Third-party relationships
The profitability of small businesses is often dependent on a handful of long-term clients and supplier relationships. Go out of your way to meet the needs of these firms or individuals, since losing their business would be a significant barrier to a future sale of your company. Ensure that your contracts with these parties ensure their continued support for your business. Keep them abreast of your plans, so that they are vested in your success and growth. Consider adding a transferability clause to your standard contract to protect a future buyer; such a clause ensures that the third-parties cannot change or terminate their relationship with you in the event of a change of ownership.
Streamline Operations and Finance
Prepare a business plan
With so much to do and limited financial resources, small businesses often neglect to keep an up-to-date business plan. As a minimum, you should review and update your business plan on an annual basis. As part of your plan, you should define your one-year strategy in light of the current state of your industry and its future growth prospects.
Many businesses use a SWOT analysis (Strengths, Weaknesses, Opportunities and Threats); while such an analysis is very helpful to your internal team, it takes courage to disclose weaknesses and threats to a potential buyer. You should identify how your product or service is better positioned to succeed in the marketplace than those of the competition (cost, quality, marketing, etc).
Document key processes
It is important to set up repeatable systems and procedures as your company scales from a startup into an established business. The larger and more complex your business becomes, the harder these processes are to track, or explain orally. To allow a potential buyer to understand your company as rapidly as possible, ensure that you keep written records of these processes and update them regularly. This can be done through a Standard Operating Procedures manual.
Keep finances in order
Your business plan should include 3-5 year financial projections to give a buyer an idea of your company’s growth potential. The more a buyer can mitigate financial risk (such as through on a backlog of orders or contracts to guarantee future revenue), the more attractive your business becomes as a potential investment. Another way of stressing profitability to a buyer is to clarify which current business expenses the buyer will not incur after the sale; one example might be the bonuses of management who would leave in the event of an acquisition. In order to demonstrate the reliability and accuracy of your financial information, you should also have your financial statements audited annually by an independent professional. Buyers place very significant value on audited financials.
Get a valuation
At all times, you should have a good idea of the ball price your business may fetch. Speak to a business broker to find out informally what you may get for your business. You can also get a formal valuation done. Alternatively, analyze recent deals of a comparable size within your market sector.
Improve Corporate Image
First impressions are very important in a business sale negotiations. You can preemptively enhance and protect your corporate image prior to the sales process by doing the following:
Public Relations
Keep a clear record of any initiatives you may have undertaken to build your company’s standing in the local and global community. You should also gather positive customer testimonials and use them in your marketing collateral such as on your website.
Avoiding legal difficulties
As part of the due diligence process, a potential buyer will always ask for information on past or current litigation involving your business. You should maintain a summary of your company’s legal affairs and have this close to hand in any negotiations. Also, ensure that you are compliant with all the regulatory requirements affecting your business, and file for patents and copyrights to protect any intellectual property you might own if appropriate. Similarly, deal with customers and vendors in a trustworthy and fair manner so that you are not involved in any litigation that will reflect poorly on your ethics or business practices. In a business sales situation, such litigation can come back to haunt you seriously.
Keeping premises tidy
Speak with your office manager to ensure that your office is kept in good order! Your decor and office setup should appear professional, contracts and other paperwork should be organized and be easily accessible. Product inventory should be clearly cataloged. If your business owns a factory, keep your equipment in good working condition and sell any obsolete machinery.
Plan your Tax Strategy
Prior to starting negotiations for the acquisition of your business, evaluate your options that can maximize your net “take home” proceeds from the sale and can reduce your tax burden legally. For instance, in certain jurisdictions (such as Singapore) can avoid paying any capital gains tax on gains that you have from the sale of your equity whereas other jurisdictions may impose as high as 35% tax on the same. Similarly, a jurisdiction such as Singapore imposes no tax on the dividends you receive from the company whereas others impose a tax as high as 55% on dividends. Thus, in Singapore you can structure the sale as a combination of A) a pre-sale dividend, followed by B) a sale of your equity and pay no tax on any of these proceeds. But this may not be possible in a different jurisdiction. Thus, early planning of your corporate structure whereby your firm is domiciled an a jurisdiction that provides a tax efficient mechanism for a sale can dramatically alter your tax home proceeds.
Similarly, a few other things to keep in mind:
Negotiate to sell your shares
A key part of negotiations is whether the buyer will purchase the shares or the assets of your business. Depending on the jurisdiction, selling the shares often enables your to obtain a tax exemption for a large proportion of your gain from the sale.
Make the buyer pay
Look for ways to pass the primary burden of tax from the sale to the buyer. For example, by valuing your company’s tangible assets at a higher price than its intangible ones, you can ensure that the bulk of the purchase is subject to sales tax, rather than a capital gains tax (assuming you are facing a non-zero capital gains tax which may not be the case if your company is based in Singapore). Sales taxes are normally the responsibility of the buyer.
Set up a holding company
If your sale proceeds are substantial, it may be advantageous to set up a holding company or trust to help you manage the money. The latter may also offer an excellent way to provide asset protection and inter-generational wealth transfer, while minimising income, gift and estate taxes.
Philanthropy
Rather than frittering away your wealth on ostentatious luxuries such as yachts and fancy cars, you may be able to reduce your tax burden via philanthropy. Many charitable donations are tax-deductible.
Start a new business
If you plan to found a new company with the proceeds from the sale of your company, you may be able to offset some of the taxes arising from the sale by investing in new hires and equipment.
Get professional advice
This website does not provide tax advice. To find the most appropriate solutions for your business in your particular jurisdiction, you should consult with a CPA or equivalent professional.
Learn the Sales Process
Before you decide to sell, you should be prepared for the mechanics of the challenging sales process that awaits you. Assume between four to six months of hard work into your plans, although do bear in mind that there are some businesses that sell in a matter of weeks and others can take more than a year. The process outlined below assumes that you have already decided to sell and kept an eye on your finances, operations and business relationships to maximize the chances of a successful sale. You should review this process and you should have a good understanding of it even before you decide to sell. Keep this in the back of your mind as you meet industry experts and business brokers so that you can take mental notes about who you may seek out when you do decide to pull the trigger.
Find an advisory team
Your first step will be to hire the professional advisors who will see you through the sale of your business while avoiding legal troubles. Look for a law firm with experience in your industry and transactions of a similar size, and aim to work with one of their senior partners. You may want to interview several firms and double-check references before you choose the lawyer with whom you get on with the best. Next, you will need a broker or investment banker with a large network in your industry to help you identify buyers.
Advertise to multiple buyers
With your core advisory team in place, use your broker’s network to advertise the sale of your business to as many potential buyers as possible. Having multiple buyers gives you leverage in negotiations, incentivizing competing buyers to outbid each other in order to acquire your business. You should keep on the look out for potential buyers even before the decision to sell. Establish good relations with buyers who may be suitable in the future.
Negotiation and due diligence
This is the longest part of the sales process. You will have to come to an agreement about whether the buyer will acquire your company’s assets or just its stock. A key part of negotiations is often the earn-out clauses, in which a portion of the sales price is contingent on the business reaching certain financial targets in the years following acquisition. Sometimes, it is possible to agree to mitigate some of the immediate expense of the sale under a seller financing agreement. As negotiations move forward, the buyer’s lawyers will contact you with regular requests for accounting, financial and legal information. Become familiar with this process so that you can tailor your business profile such that it will pass the due diligence requirements with flying colors.
Conclusion
The decision to sell your business will be driven by your personal objectives as well as factors that may be beyond your control. Therefore, preparing ahead of time for the sales process is a very wise move. Such preparation involves optimizing your corporate structure, good record-keeping and maintaining a professional image with key stakeholders in your business. These activities will not only benefit a potential buyer, they will benefit your business too.
When grooming your business for sale, put yourself in the shoes of a perspective buyer and take actions that will reduce the risk and uncertainty associated with your business. Through intelligent financial planning and common-sense management, you can minimize the time it takes to sell and maximize your company’s value as an investment in case you confront a situation where you have to execute a sale quickly.
