A Small Business Owner’s Guide to Choosing the Right Exit Strategy: Part 1

Published by Matt Brady | June 30, 2020

A strategically crafted exit plan is key for small business owners looking to ensure that their company is optimally positioned to successfully transition to new hands. Ideally, the time to start putting together your exit strategy is several years in advance of a planned transition, but recognizing that some transitions are not planned or expected makes the case for developing an exit strategy even earlier in the life of your business.

In the last article in this series, we focused on defining what an exit strategy is–a plan for guiding the business you worked so hard to build into its next phase—and what it most definitely is not—a sign of failure or giving up on your business. We discussed who needs an exit strategy—every business—and the components that make up an exit strategy—self-reflection, establishing your team, choosing your strategy, conducting a valuation of your company, and creating your action steps and time table.

In this article, we’ll begin to take a deeper dive into one of those key elements of exit planning: choosing a strategy. There is a range of options, each with its pros and cons, and which is best for you depends on your circumstances, your long-term vision for your business, your goals, and the degree to which you wish or do not wish to remain involved after the transfer of leadership. The following are two exit strategy options to consider in consultation with your family, partners, and trusted advisors:

 

Family Succession

Family succession involves passing your business on to a family member. There are many advantages to choosing this strategy, but chief among them are the operational and public relations benefits of continuity. Family members have often grown up in the business, and generally need less onboarding time than an outside buyer. The company’s values, mission, and culture are also more likely to be understood by someone intimately acquainted with the business.

Passing the business on to a family member can also save the time and expense of seeking out and vetting external buyers and going through possibly lengthy sales negotiations. Additionally, an inherited business that is managed wisely can be a sound source of continuing income for heirs.

There are potential drawbacks to family succession, however. Depending on how you pass the business on—as a gift, or at a price significantly lower than its market value—there may be major tax implications. Beyond that, a recent UBS Report noted that 82% of family members would rather have the money from the sale of the business than actually take over the business themselves. The same report relays that a full 89% of business owners surveyed did not plan to pass their business on to family because they do not see enough interest on their part in running the business.

Family succession, like any other strategy, has the potential to go wrong, but when it does, the damage can be more significant because in addition to the possibility of lost revenue, there is also the danger of causing a family rift. In the worst cases, family relationships can be poisoned by arguments and even litigation.

If you do decide to pass your business on to a family member, here are some points to keep in mind to reap the many benefits of this exit strategy while safeguarding against potential pitfalls:

  • Have honest conversations with your family to discuss their interest in and aptitude for taking over the business.
  • Involve an objective third party as an advisor who can help you see past the emotion that accompanies family relationships and that may cloud your business judgment.
  • Don’t bypass the paperwork. It may feel overly formal to create a documented succession plan if the successor is a family member, but clearly spelling out everyone’s roles and expectations will ensure that all are on the same page, and stave off avoidable misunderstandings.
  • Don’t bypass the training. As mentioned, a family member will often need less onboarding than an external buyer, but don’t assume that your successor knows everything you do simply by having been around the business, or even having worked in it. Invest the time to make sure you’ve successfully transferred the requisite skills and knowledge to your successor.
  • Set the business up for a peaceful transition and future. If you are passing the business on to one family member, consider involving the rest of the family on a board to ensure that all members have a voice and that there is a forum for resolving disagreements amicably and fairly.

 

Employee/Management Buyout

Employee or management buyout is when an individual or group of employees or managers already working with you buys the business from you.

The pros and cons for this type of exit strategy are very similar to those of family succession, with advantages including eliminating spending time and money on finding, vetting, and negotiating with an external buyer.

The benefit of continuity may be even stronger with an employee or management buyout than with family succession as, unlike family members, employees and managers are assured of already being involved in the operation and running of the business. Also, since they are already working in the business, chances are higher that they have the interest to continue in it.

The disadvantages to employee/management buyout include potential delays in securing the funding to purchase the business but, as with family, one of the greatest drawbacks is the emotion that may come with personal relationship. If you are close to the employees or managers who are buying you out, you may be hesitant to ask for the full value of your business, or less diligent about formalizing the details of the sale and succession plan.

If you opt for this type of exit strategy, here are some points to keep in mind:

  • This is still a business transaction, even if it is among friends and people who have worked with you for years. You will actually support that friendship by being clear in your negotiations and business dealings.
  • Bring on a third-party advisor, just as you would with family, and for the same reasons.
  • Have an open and honest discussion with the employees or managers who are buying you out about to what degree, if any, you should remain involved after the sale. Sticking around as the former owner may inadvertently undermine the authority of the new owners to take the reins and move the business forward.

Family succession and employee/management buyout can both be sound, profitable exit strategies if entered into with care and forethought. In our next article, we’ll examine additional exit strategies to round out your options as you consider, in concert with your small business CPA firm and legal counsel, what course will best serve you, your family, and your business in the future.

 

Image Credit: Steven Rindner (Flickr @ Creative Commons)