This article originally appeared in the December 2016 issue of Smart Business Philadelphia magazine.
It’s not a question of if a business owner will exit his or her business, but more a question of when, says Mark Metzler, a director and Certified Exit Planning Adviser (CEPA) at Kreischer Miller. A recent Exit Planning Institute (EPI) survey indicates 76 percent of business owners plan to transition over the next 10 years, and 48 percent in the next five years.
These projections are driven by the fact that the first baby boomers turned 65 in 2011 and 10,000 more boomers turn 65 every day, with the youngest members of this group now in their early 50s.
This generation owns 63 percent of the private businesses in the United States, and their businesses represent 80 to 90 percent of their personal net worth. Soon, however, they’ll need to consider the next step for their respective businesses.
Smart Business spoke with Metzler about the value of developing an exit strategy for this inevitable outcome.
If an owner isn’t looking to sell, why is an exit strategy important?
Every business will ultimately face the issue of the owner’s exit. It is therefore critical to have an effective transition or liquidity plan in place.
Exit planning is a business strategy for owners to maximize enterprise value while enabling the conversion of ownership into personal freedom and peace of mind. In Peter Christman’s book, “The Master Plan,” he compares a successful exit strategy to a three-legged stool. Each leg is critically important. The first leg is maximizing the value of the business; the second leg ensures that the business owner is personally and financially prepared; and the third leg ensures that the owner has planned for life after the business.
What are the exit options available to a business owner?
There are two general categories for private ownership transition: An inside transition or an outside exit.
An inside transition comprises the following types:
- An intergenerational transfer is a transfer of business stock to direct heirs, usually children. Approximately 50 percent of business owners want to exercise this option, but in reality, only about 30 percent do so. This option is often an issue of estate planning rather than structuring a transaction. An advantage to this option is business legacy preservation.
- In a management buyout, the owner sells all or part of the business to its management team. Management uses the assets of the business to finance a significant portion of the purchase price, with the owner often providing additional financing. This option provides for management continuity, but it also introduces financing risk to the seller.
- A sale to existing partners is typically less disruptive, but the success of the transition is closely linked to the existence and quality of a buy-sell agreement.
- A sale to employees may be accomplished through an ESOP, where the company uses borrowed funds to acquire shares from the owner.
Conversely, an outside exit may entail:
- A sale to a third party, where the owner sells the business to a strategic buyer, a financial buyer or private equity group through a negotiated sale, controlled auction or unsolicited offer. This is typically a long process, but may result in the highest price.
- A recapitalization or refinance involves finding new ways to fund the company’s balance sheet. A new lender or equity investor (minority or majority position) is brought in as a partner. This may permit the owner a partial exit, while providing growth capital.
- An initial public offering or the expression “going public” involves the registration and sale of company securities (common or preferred stock or bonds) to the general public — a costly option not practicable for the majority of privately owned businesses.
- In an orderly liquidation, the asset value is greater than the value of the business as a going concern. The business is shut down and its assets are sold.
An effective exit strategy begins long before an actual exit, as maximum value is optimized when an exit is proactive rather than reactive. Early planning provides knowledge that the business owner, not the potential buyer, will drive the exit process to achieve personal goals and objectives. ●
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