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January 6th, 2012
Four Ways To Leave Your Business – Which One Is Right For You?
Selecting your successor is a fundamental objective that is decided early in the Exit Planning process. Almost all owners want to transfer the business to other family members, an employee or a co-owner; only about 5 percent want to sell to an outside third party. Interestingly, however, most persons first identified as successors do not usually end up as the ultimate owners.
Choosing your successor involves a careful assessment of what you want from the sale of your business and who can best give it to you. There are only four ways to leave your business. If you know these methods and decide in advance which one you prefer, then you have a better chance of leaving your business under terms and conditions you choose. Without planning you are more likely to settle for terms and conditions beyond your control.
1. Transfer of Ownership to Your Children
50 percent of typical business owners want to transfer their business to their children. Fewer than one in three of these owners end up doing so. Because this is the riskiest way to leave your business, you must prepare for failure by developing a contingency plan to convey your business to another type of buyer.
Transferring a business within the family fulfills many people’s personal goals of keeping their business and family together. It can provide financial well-being for younger family members unable to earn comparable income from outside employment, as well as allow you to stay actively involved in the business with your children until you choose your departure date. Transferring your business to your children will also afford you the luxury of selling the business for what you need to live on, even if the value of the business does not justify that sum of money. You will determine how much you need or want, rather than be told how much you will get.
On the other hand this option also holds great potential to increase family friction, discord, and feelings of unequal treatment among siblings. The normal objective of treating all children equally is difficult to achieve because one child will probably run or own the business at the perceived expense of the others. At the same time financial security is normally diminished rather than enhanced and the very existence of the business is at risk if it’s transferred to a family member who can’t or won’t run it properly. In addition the vagaries of family dynamics may also significantly diminish your control over the business and its operations.
2. Sale to Other Owners or Employees
One of the great advantages of having other owners in your business is that they can be your means to retirement. Especially with smaller businesses, a common retirement planning technique is to have a younger individual buy into your business while you are still active. Upon your retirement, the younger owner will purchase your remaining stock.
This plan can be advantageous because the younger person learns the business – its structure, employees, customers, operation, and management – under your tutelage. More important for you, the younger person’s capabilities (as well as his weaknesses) are known to you, so you have a pretty good idea of how your business will be run after you leave. And most important of all, the business can be sold to a market you create and control. You structure the deal ahead of time to suit your particular needs and objectives.
Disadvantages in this plan are that there is no cash up front, unless you as the owner have pre-funded the sale, but even then, you have probably pre-funded with money that was yours anyway. A great risk also exists in the fact that the buyout money comes from the future earnings of the business after you leave it. Employees are often employees because they don’t have an owner “mindset.” They’re not entrepreneurs and they don’t respond well to the challenges and pressures of ownership. These disadvantages apply especially to businesses worth more than $2 million. The owner simply has too much money and financial independence at risk, and the price will be too high for an employee to afford.
3. Sell It To A Third Party
In a retirement situation, a sale to a third party too often becomes a bargain sale – the only alternative to liquidation. But if the business is well prepared for sale this option just might be your best way to cash out. In fact you may find that this so called “last resort” strategy just happens to land you at the resort of your choice.
Although many owners don’t realize it, you should get most or all of your money from the business at closing. Therefore, the fundamental advantage of a third party sale is immediate cash or at least a substantial up front portion of the selling price. This ensures that you obtain your fundamental objectives of financial security and, perhaps, avoid risk as well. A second unanticipated advantage in selling to a third party is the ability to frequently receive substantially more cash than your CPA or other business appraiser anticipated because the market place is “hot.” Finally, this may be the best option for a business that is to valuable to be purchased by anyone other than someone who has access to a considerable source of money.
If you do not receive the bulk of the purchase price in cash, at closing, however, your risk will suddenly become immense. You will place a substantial amount of the money you counted on receiving in the unpredictable hands of fate. The best way to avoid this risk is to get all of the money you are going to need at closing. This way any outstanding balance payable to you is “icing on the cake.”
4. Liquidate It
If there is no one to buy your business, you shut it down. In a liquidation the owners sell off their assets, collect outstanding accounts receivable, pay off their bills, and keep what’s left, if anything, for themselves.
The primary reason liquidation is considered is that a business lacks sufficient income-producing capacity apart from the owner’s direct efforts and apart from the value of the assets themselves. For example if the business can produce only $75,000 per year and the assets themselves are worth $1 million, no one would pay more for the business than the value of the assets.
Service businesses in particular are thought to have little value when the owner leaves the business. Since most service businesses have little “hard value” other than accounts receivable, liquidation produces the smallest return for the owner’s lifelong commitment to the business. Smart owners guard against this. They plan ahead to ensure that they do not have to rely on this last ditch method to fund their retirement.
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