“Plans are of little importance, but planning is essential.” -Winston Churchill
Every Business Owner Should Have An Exit Strategy
A business exit strategy is the means by which an entrepreneur or business owner will liquidate or sell their ownership stake in a business. Options include going public as an Initial Public Offering ‘IPO’, selling to a competitor, selling to a family member, or selling to a private individual or firm. Prospective business sellers should contemplate the financial and lifestyle impact of choosing their best exit strategy. No matter the reason for exiting a business, the selling process should never disrupt the business operations and must be handled confidentially by a professional business broker. As part of an exit strategy, business owners should have an accurate set of historical records available for review so an experienced business broker may give a fair business evaluation. The exit strategy should align with favorable market conditions and should always address the 5 D’s requiring contingency planning: Divorce, Disagreements, Death, Destruction, and Disability.
Discuss Exit Strategy with Business Broker
It is always best for a business owner to think about their exit strategy in the context of what makes the most sense from the perspective of potential buyers. For example, investors in an IPO may prefer a business with a high growth rate while a private equity buyer may prefer a business to have a high degree of recurring sales. Professional business brokers should determine the most realistic set of buyers for a business, and what characteristics of the business will be most attractive to that specific group of buyers. Often this depends on the size of the business and to what extent the deal may be financeable for certain buyers.
Discuss Financial Impact of Exit Strategy
Most successful South Florida business sell due to pending retirement or a desire to pursue another life-fulfilling pursuit. No matter the reason, prospective business sellers formulating their exit strategy must ultimately decide on whether the proceeds from the sale are worth the loss of income that they will no longer receive from their ownership stake in the business. The opportunity cost (as represented by the lost future income from not owning the business) must be weighed against the luxury of receiving immediate proceeds from the sale. Most business owners also strive for the freedom of no longer having ownership responsibilities. The degree to which the business seller will rely upon the income from the sale to cover their future retirement needs depends upon the seller’s age and future plans.
The 4% Rule A General Financial Guide
In thinking about the financial impact of a planned business exit strategy, it is very helpful for prospective business sellers to be aware of the 4% rule. Prospective retirees use this general rule of thumb to decide how much they can or should withdraw from their retirement funds each year. The rule was established by financial experts and posits that a retiree may safely withdraw 4% of their retirement account annually over any 33-year time period so long as the account stays invested in a mix of publicly traded stocks and bonds. The rule is intended to assume a very conservative ‘worst case’ compounded rate of return. Experts differ on whether the withdrawal amount may be slightly more, but a 4% annual withdrawal rate is generally considered safe.
Example of Applying 4% Rule to Business Sale
- When determining the future income needed from a prospective sale, it is very useful for prospective business sellers to consider the 4% rule.
- Let us suppose that Bill owns and operates Bill’s Auto Shop and is contemplating his exit strategy.
- Bill is 60 and nearing retirement, but knows that he has no family members or employees that can buy the business for anything close to the amount that will sustain his retirement.
- Discussing the matter with a professional business broker, Bill is told that his auto shop is worth around $500K.
- Is this enough to sustain his retirement?
- Using a retirement calculator and the 4% rule, one may determine how Bill’s future income from the $500K in proceeds will look compared to the 4% annual withdraw he plans to implement for his retirement.
- Using an 8% annual compounded growth rate for his $500K of proceeds, a 2% annual compounded inflation rate, and a 4% annual withdraw rate, Bill’s nest egg from the $500K business sale will actually triple in size after a 33 year time period (to around $1.6M).
- The 4% annual withdraw rate means Bill may start withdrawing $20K/year after the sale, but Bill’s annual withdraw from the retirement account increases in size to over $60K/year after 33 years!
- Moreover, note that the assumption of an an 8% annual compounded growth rate over time is pretty conservative.
- The average 30 year compounded annual return for the S&P 500 (publicly traded stocks) is actually 10.7%.
- In any event, Bill now understands approximately how much retirement savings he needs which better enables him to formulate his business exit strategy.
Discuss Lifestyle Goals from Exit Strategy
In addition to the very important financial effects from a business exit strategy, a business owner should also understand how the exit strategy will affect their lifestyle goals. Some business owners long for retirement and wish to simply relax without having the stress of owning and operating a business. They may thus not want the burden of having to carry any ‘seller financing’ as a part of the deal.
Seller-Financed Deals
A seller-financed business deal means the seller accepts partial payment of the purchase price in return for a Note. The buyer must make monthly payments on the Note over an agreed upon time period (typically 2-3 years). Apart from the financial risk, a seller-financed deal means that the seller can not totally relax after the sale. They will often have some level of involvement in the business after the closing in order to assure the buyer makes good on the Note. If the business seller’s goal is to be stress-free with no future worries over the business, then they should avoid seller-financing.
Non-Compete Agreements Affect Exit Strategies
A business seller contemplating their exit strategy must also be aware that the vast majority of buyers will require the seller to give a non-compete agreement as a condition to close. A non-compete agreement governs the extent to which the seller of the business (or their family members) are forbidden from owning, operating, or even working for a business within the similar industry for a prescribed time period and geographic area. Non-competes are always negotiable and are typically broader when the seller has particular skills or knowledge within the industry. Prospective sellers who may plan on owning or working in the same industry after the sale should be keenly aware of how non-compete agreements may affect their lifestyle plans.
Planning one’s exit strategy – even if it seems like a long away – is well worth the effort in order to give a prospective business seller peace of mind and financial security.
Give Martin at Five Star Business Brokers of Palm Beach County a call today for a FREE evaluation of your business.