Running a successful business requires careful planning and strategic decision-making - there are so many moving pieces in play and often, a lot of these pieces are neglected or even forgotten about. Creating a business exit strategy is essential to ensure a smooth transition.
Exit strategies are often neglected - many business owners are unsure whether they need one; or, they may have heard of different exit strategies but are confused about which one is right for them. Understanding the importance of creating a business exit strategy can clarify these doubts.
Whether someone is planning to retire, sell their business, or pass it on to the next generation, creating a business exit strategy can help them achieve their goals while minimising risks and maximising value.
In this article, we’ll go into the details of what a business exit strategy is, why businesses need one, and 7 common exit strategies that companies can implement for effective planning.
What Is A Business Exit Strategy?
A business exit strategy is a plan that outlines how the owner of a company can sell their investment in their business - it is essentially a roadmap for creating a business exit strategy and successfully walking away.
If you’re a business owner wanting to sell or close down your company, or are looking to advise someone on selling their company, you’ll need a good exit strategy to make it work.
Ideally, an exit strategy plan should be created even before even starting a business, so business owners can make adjustments as the market evolves.
Why Businesses Need Exit Strategies
All companies need an exit strategy because nobody lives (or works) forever. One owner might want to retire, get employed somewhere else or maybe even start a new business in a different industry. Some owners might want to pass on their business to their family or a new generation.
Whatever the reason, leaving a company can be very stressful for owners if they haven’t developed a proper exit plan. Business owners who’ve spent years building an empire can get emotional about their exit, resulting in clouded judgement and poor decisions as they walk out the door.
Here are some things to consider when creating an exit strategy:
- Goals: What are the owner’s personal goals and objectives for exiting the business? Are they looking to maximise their return on investment, ensure a smooth transition to new ownership, or achieve a certain valuation or financial target?
- Timing: When does the owner plan to exit the business? Is there a specific timeframe or event that will trigger their exit, such as retirement, a change in personal circumstances, or a market opportunity?
- Business valuation: What is the current value of the business, and what factors will impact its future valuation? Will the owner need to take steps to increase the value of the business before exiting?
- Exit options: What are the different exit options available to the company, and what are the pros and cons of each? Should you consider a sale to a third party, a family succession plan, or an IPO, among other options? We’ve outlined all the most common options in the following section.
- Due diligence: What information and documentation will potential buyers or investors require during due diligence, and how can the owner ensure that this information is organised and easily accessible?
- Legal and financial considerations: What legal and financial issues should the owner consider when creating an exit strategy? Will they need to work with lawyers, accountants, or other professionals to ensure a smooth and successful exit? Are there any investors in the business that are expecting returns? Are there any creditors the company has who will need to be paid back if the business closes (this may even include the company’s own employees)?
- Communication: How will you communicate your plans to employees, customers, and other stakeholders, and how can you ensure a smooth transition for all involved parties?
If a company develops a robust roadmap in the early stages of the business, it can help owners make the right decisions throughout the lifetime of their company’s operations.
Business owners should revisit their strategy as often as they can, to see if it still fits within their goals and current situation. Circumstances change - for example, a company might start off with one investor but then will grow to receive hundreds of other investors. In this case, the change in number of investors will have a big impact on the company’s exit strategy.
7 Common Exit Strategies For Business Owners
There is no need to reinvent the wheel when it comes to business exit strategies. There are many types of common ways to leave a business, and each one has their own advantages and disadvantages.
Below is a comprehensive review of 7 of the most common business exit strategies to consider.
Family Succession
A business owner may elect to sell their company to a friend or family member. Keeping business in the family is a common way to walk out the door, but it is important to know that this option may not always ensure the owner’s legacy is maintained.
Pros
- Keeps the business in the family: A family succession plan allows the business to stay within the family and continue to be operated by family members. This can be important for business owners who want to maintain their legacy and ensure that the business continues to thrive.The owner may also still be involved informally as an advisor.
- Continuity of operations: Family succession is generally an easy transition for the business owner to make. A family succession plan can provide continuity of operations, as family members are likely to be familiar with the business and its operations. This can help to ensure a smooth transition and minimise disruption to the business.
- Preserves culture and values: A family succession plan can help to preserve the business’s culture and values, which can be important for maintaining the business’s reputation and relationships with customers and suppliers.
- Reduced risk: A family succession plan can reduce the risk of the business being sold to an unknown buyer, which can be important for business owners who are concerned about the long-term viability of the business.
Cons
- Potential for family conflict: Family succession plans can be complicated and may lead to conflicts among family members, particularly if there are disagreements about who should take over the business.
- Limited pool of potential successors: A family succession plan limits the pool of potential successors to family members, which can be a disadvantage if there are no suitable candidates or if family members are not interested in taking over the business.
- Lack of expertise: Family members may not have the expertise or experience to run the business, which can lead to difficulties in managing the business and ensuring its long-term success.
- Difficulty in valuing the business: Valuing the business for a family succession plan can be challenging, particularly if there are no comparable sales or if family members have different ideas about the value of the business. It’s also tempting to sell the business at ‘mate’s rates’ below what the business is worth.
- Business may be perceived as nepotistic: The business’ reputation might be damaged if potential investors or customers begin to view the business as nepotistic.
Employee Or Management Buyout
Another common route people take when devising an exit strategy is to sell the business to an existing employee or manager within the business.
The owner may choose to sell the business to the employees through an employee share ownership plan (ESOP). This can be a good option if the owner wants to ensure that the employees are committed to the long-term success of the business.
In a management buyout, the current management team buys the business from the owner. This can be a good option if the owner wants to ensure the business is left in good hands and the management team has a vested interest in the company’s success.
Pros
- Smooth transition: An employee or management buyout can provide a smooth transition of ownership and management, as the existing employees or managers are already familiar with the business and its operations.
- Reduced risk: An employee or management buyout can reduce the risk of the business being sold to an unknown buyer, as the existing employees or managers are likely to have a good understanding of the business and its future prospects.
- Retention of key employees: An employee or management buyout can help to retain key employees who might otherwise leave the business after a change in ownership. This can be important for maintaining the business’s knowledge and expertise.
- Alignment of interests: An employee or management buyout can align the interests of the new owners with those of the business, as they are likely to be committed to the long-term success of the business.
Cons
- Limited pool of potential buyers: An employee or management buyout limits the pool of potential buyers to the existing employees or managers, which can be a disadvantage if there are no suitable candidates or if the business is not attractive to the existing employees or managers.
- Limited access to capital: The existing employees or managers may not have the financial resources to purchase the business outright, which can limit their ability to complete the buyout.
- Lack of outside perspective: An employee or management buyout can limit the business’s access to new ideas and perspectives, which can be important for maintaining the business’s competitiveness and growth.
- Conflict of interest: An employee or management buyout can lead to conflicts of interest between the new owners and other employees or managers, particularly if there are disagreements about the direction of the business.
Trade Sale
One of the most common exit strategies is to sell the business to another company. This can be done through a direct sale or by hiring a business broker.
Pros
- Potential for a high payout: A trade sale can provide the owner with a significant payout if the business is sold for a good price. This can be particularly attractive if the owner is looking to retire or move on to other ventures.
- Faster exit: A trade sale can be a quicker way to exit the business compared to other strategies such as an IPO or employee ownership.
- Reduced risk: Selling the business to another company can reduce the owner’s risk exposure and provide them with a sense of security knowing that the business is in good hands.
- Access to resources: If the business is sold to a larger company, the new owner may have access to more resources such as capital, technology, and expertise which can help the business grow and develop.
Cons
- Loss of control: Selling the business means the owner will lose control over the direction and management of the business. This can be difficult for some owners who have put a lot of time and effort into building the company.
- Potential for culture clash: If the business is sold to a larger company with a different culture and values, this can cause conflicts and difficulties in integrating the two organisations.
- Lack of confidentiality: The process of selling the business can involve sharing sensitive information with potential buyers which can be risky and potentially harmful to the business.
- Disruption to operations: The process of selling the business can be disruptive to day-to-day operations which can impact the business’s performance and profitability.
Merger
A merger involves two companies combining into one company. Typically, this tends to increase a business’ value and investors tend to prefer these types of exit strategies for this reason.
Mergers generally require the business owner to still be part of the business. Owners will usually manage the business through the merger itself, and the employees may still remain in the employment of the new company.
Pros
- Potential for a high payout: A merger can provide the owner with a significant payout if the business is sold for a good price.
- Synergy: A merger can create synergy by combining the strengths of both businesses, such as complementary products, markets, or expertise. This can lead to increased efficiency, reduced costs, and increased revenue.
- Increased market power: A merger can increase the market power of the merged entity, allowing it to negotiate better prices with suppliers and gain a larger share of the market.
- Diversification: A merger can provide diversification, allowing the merged entity to reduce its risk by spreading its operations across multiple products or markets.
- Increased shareholder value: A merger can create value for shareholders by increasing the value of the merged entity, leading to higher stock prices and dividends.
- Save a failing company: A merger can save a business that is failing.
Cons
- Integration challenges: A merger can be difficult to integrate, particularly if the two businesses have different cultures, systems, or processes. This can lead to disruptions in operations, delays, and additional costs.
- Regulatory hurdles: A merger may require regulatory approval, which can be time-consuming and costly. In some cases, regulatory authorities may block the merger altogether.
- Dilution of control: A merger can dilute the control of existing shareholders, particularly if the merged entity is large or if new shareholders are introduced.
- Cultural clashes: A merger can lead to clashes between the cultures of the two businesses, which can be difficult to resolve and may lead to a loss of key employees.
Acquisition
Sometimes, another business or even a competitor may wish to acquire a business owner’s company. This could work well for the owner, as the business may be a strategic part of that company’s expansion (and may be willing to pay a high price to fulfil that strategy).
Sometimes, the owner will be offered a job in the company buying their business. If so, the owner will want to make sure they’re happy with the new role and understand the culture of the new business. It can be difficult to be ‘bought out’, and no longer be in control of a company that was once theirs, so this is something a business owner would need to be prepared to do.
Pros
- Potential for a higher payout: An acquisition can often result in a higher valuation for the business than other exit strategies, as the acquirer is typically willing to pay a premium for the business.
- Liquidity: An acquisition can provide the business owner with immediate liquidity, allowing them to realise the value of their investment and use the proceeds for other purposes.
- Limited liability: An acquisition can limit the business owner’s liability, as the acquirer will typically assume any liabilities associated with the business.
- Future prospects: An acquisition can provide the business with a better future prospect, especially if the acquirer has resources that can be used to grow the business.
- Save a failing company: An acquisition can save a business that is failing.
Cons
- Loss of control: An acquisition can result in the business owner losing control of their business, as the acquirer will typically take over the management and decision-making processes.
- Cultural differences: An acquisition can lead to cultural differences between the two businesses, which can be difficult to reconcile and may lead to a loss of key employees.
- Integration challenges: An acquisition can be difficult to integrate, particularly if the two businesses have different cultures, systems, or processes. This can lead to disruptions in operations, delays, and additional costs.
- Regulatory hurdles: An acquisition may require regulatory approval, which can be time-consuming and costly. In some cases, regulatory authorities may block the acquisition altogether.
Initial Public Offering (IPO)
An initial public offering (IPO) is when a business sells stock to the public for the very first time. Business owners typically don’t use IPOs as an exit strategy, but rather as a way to raise capital.
IPOs are a massive and expensive endeavour for any business. It also means becoming public, and so subject to even more federal reporting requirements such as rules in the Corporations Act 2001 and the ASX listing rules. The IPO option is not something to take lightly.
Pros
- Valuation: An IPO can result in a high valuation for the business, providing the business owner with a significant return on investment.
- Liquidity: An IPO can provide the business owner with immediate liquidity, allowing them to realise the value of their investment and use the proceeds for other purposes.
- Public exposure: An IPO can provide the business with greater public exposure, which can help to increase its visibility and brand awareness.
- Access to capital: An IPO can provide the business with access to additional capital, which can be used to fund growth and expansion.
Cons
- Costs: An IPO can be expensive, with significant costs associated with the process, including legal, accounting, and underwriting fees.
- Time-consuming: An IPO can be a lengthy and time-consuming process, taking several months or even years to complete.
- Loss of control: An IPO can result in the business owner losing control of their business, as the company will now be subject to the scrutiny of public shareholders.
- Regulatory compliance: An IPO can result in increased regulatory compliance requirements, which can be time-consuming and expensive to maintain.
Liquidation
Liquidation is the procedure of shutting a business down forever, selling all of its assets or redistributing them to the company’s creditors. One judge of the Federal Court of Australia said that liquidation “usually spells the death of a company.”
Liquidation can occur if a company is solvent (i.e. able to pay off its debts when they become due and payable) or insolvent. It is typically a clear strategy because a business owner doesn’t need to negotiate or sell their business to somebody else. Put very simply, the company stops running, the assets are sold, and the money goes to the company’s creditors.
So, who exactly gets the money from a liquidation? In Australia, there is a priority of payment as follows:
- The liquidator - The liquidator, who becomes in charge of a company in liquidation, pays themselves out of the company first.
- Secured creditors - these creditors get priority after the costs of liquidation are paid. These are the creditors with security interests (for example, a mortgage or charge) over the assets of the company, and typically include companies like banks.
- Employees - employees are a form of unsecured creditor who receive priority under the law. This includes payments of outstanding wages. If there are enough funds available after secured creditors are paid, employees are next on the list.
- Unsecured creditors - These creditors have no security or collateral over the company’s assets. They could include people like trading partners. These creditors will be paid on a pro rata basis if there are any funds left over after secured creditors, employees and the costs of liquidation are paid.
Pros
- Immediate closure: A liquidation can provide the business owner with an immediate closure, allowing them to quickly exit the business.
- Simplicity: A liquidation can be a simple and straightforward process, requiring minimal legal and regulatory requirements.
- Debt settlement: A liquidation can be used to settle outstanding debts, allowing the business owner to avoid personal liability for the debts.
- Tax benefits: A liquidation can provide certain tax benefits, such as the ability to write off certain losses or deduct certain expenses.
Cons
- Low valuation: A liquidation can result in a low valuation for the business, as the assets are typically sold at a discount to market value.
- Limited recovery: A liquidation can result in a limited recovery for the business owner, as the assets may be sold for less than their book value.
- Reputation damage: A liquidation can damage the reputation of the business owner, as it can be seen as a sign of failure or mismanagement.
- Employee impact: A liquidation can have a negative impact on employees, as they may lose their jobs and potentially suffer financial hardship.
Summary
Choosing the right business exit strategy requires a thoughtful and strategic approach that takes into account personal goals, market conditions, and various legal and financial considerations.
By carefully considering all of these factors and seeking the advice of professionals as needed, business owners can make an informed decision that best serves their interests and the interests of their stakeholders.
We cannot underestimate the importance of seeking advice from professionals. They are equipped with the expert guidance necessary to navigate business owners through the trenches, minimising the risks of making costly and avoidable mistakes.
While there is an initial cost for tailored advice, good strategists can help owners leave the business with more money in your pocket.