Jul 11, 2022 | Starting a Business

What is an “exit strategy,” for a business, and why do I need one?

Q. Dear Zenagos, I asked a friend of mine who graduated from business school to read my business plan, and she said I need to describe my “exit strategy.” I looked it up, and it seems to mean a contingency plan, but I don’t understand in case of what? What is an exit strategy for a business, and why do I need one?
–Emily

Your exit strategy is your plan for how you will leave your business. Most people don’t make this plan upfront – we humans are a lot better at starting things than we are at finishing them. You may feel that it’s a little early to be making your plan to exit the business. After all, you are just starting your business, and you have no idea how well (or even if) it is going to work. However, you should thank your friend for asking this question. Thinking it through will increase your chances of achieving your goals.

What are the ways you can exit a business?

Sell the Business
If you have created a lot of value in your business, then selling your business can make you very wealthy. There are many ways to sell a business:

1. Sell to an Individual
These transactions are usually handled by business brokers, who help you to create a “book,” explaining the value of your business, and then shop that story to people who are looking to purchase businesses.
2. Sell to a Competitor
This is called a “strategic acquisition,” since established companies in the same business are referred to as “strategics.” Competitors are well positioned to understand the value of your business and may be able to run your business more efficiently because they already have systems and leadership in place.
3. Sell to Your Management Team
When you want to retire, your management team may want to continue working and may see value in buying the business from you. This is referred to as a “management buyout” or MBO.
4. Sell to Your Shareholders
Your existing shareholders may be interested in buying the rest of the company’s shares. This transaction is called a “recapitalization,” since you change the “cap table,” or the list of shareholders in the company. The other shareholders buy your shares, and you take money in exchange for giving up control and participation in the business.
5. Sell to a New Investor
There are organizations that gather funds from “accredited investors” (wealthy people, referred to as “Limited Partners” in the venture) and then use those funds to buy companies, improve their operations, and then sell them at a profit. This kind of transaction is a “private equity recapitalization,” and the firms are called “private equity” organizations.
6. Sell to the Public
If your company is large and growing quickly, it may be a good choice to register your stock with the SEC and “go public” by holding an Initial Public Offering or IPO. In order to protect the public, company insiders (founders, managers, employees, and significant shareholders of the company) are subject to an initial “lock-up period” of a few months, during which they cannot sell their shares.


Transfer the Business

Many small business owners exit the business by transferring ownership to their children or other heirs. In this case, you may not receive a payment, but will transfer all assets and liabilities to the new owners.

Liquidate and Close
When businesses cannot find a buyer or transferee, they may simply close. Typically, you would sell the assets of the business, if any have value, and then file paperwork to close the business.

 

Why does it matter how you exit your business?
Not every exit makes a business owner wealthy, but it is still important for business owners to understand how exits work for a number of reasons:

No Surprises
If you understand the kinds of buyers and their motivations, you will avoid nasty surprises. You may not like some outcomes. For example, when you sell to a private company, they typically demand an “earn out” period, during which you will help them learn the business. These periods can be several years long and can have many risks. When you sell to competitors, they already have leadership, so they will often fire your former leadership team. Most investors create value by squeezing costs from the business, so if you sell to a professional investor, you may not like what they do to the quality of your product or how they treat your former employees. When you sell to the public, you are subject to a complex set of laws, which can make your exit more time-consuming. You cannot control what happens after you sell your business, but if you are informed, you can make the exit choices that are most aligned with your values.

Directed Decisions
It is a lot easier to plan a trip if you have a destination. If you know the kind of exit that you most prefer, then you can learn about how to create value for that kind of buyer. For example, competitors will be very tempted to buy a company that has customers they really want. If your customers are companies with known brands, that will make your company very tempting for strategics (existing companies in your business sector). Knowing this, you should put a lot more effort into finding branded companies and selling to them, and you should put less energy into winning smaller customers who won’t be interesting to such a competitor.

Seeing Value
People hear a lot about stock options in the media and entertainment shows, but they are often surprised to know that equity in a private company has no value unless the company sells. Options have absolutely no value if their strike price is higher than the market value of the company, even if it does sell. It is important to know how business value works, so you can see how your company could have future value. Once you learn something new, you will see it everywhere. If you invest some time in learning how companies are valued, you will make decisions that create more value for your company. If you don’t understand what creates value, you simply won’t see those opportunities. They will be invisible to you.

It may be tempting to put off thinking about the future of your business and proceed without a financial plan, a marketing plan, and an exit strategy. Many of us live our lives very happily by learning as we go. However, truly great finishers focus fanatically on their goal. With a small change of focus and a little bit of learning, you can increase the chance that you will be satisfied with the way your business story ends.

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