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Even if you’re at the early stages of a startup with no intention of leaving, having an exit strategy is crucial
by Mark Tepper, CFP, Special to Upstart Business Journal August 13, 2012
Thinking about starting a business? You might as well ponder your potential exit strategies at the same time—even if you plan on running your company for a lifetime. The reality is that most entrepreneurs don’t begin to plan their exit until an economic or life event forces their hand, neglect that can sabotage the return on a life’s investment of ideas, time, energy, and capital.
Typically, successful entrepreneurs pour countless hours into nurturing their business and managing it for growth. Weeks, months, and even years are devoted to developing processes and procedures for running the business, but barely hours or even minutes are spent on developing an exit strategy for the business owner.
Failure to plan for a graceful, financially advantageous exit from your business becomes especially problematic when the business’s value is a core component of the retirement nest egg. A well-conceived exit strategy can facilitate receipt of the maximum sale price and help ensure a comfortable retirement.
Start from square one
As a business’s sale is considered, it is important to start from square one. Detach yourself from your role as owner and begin to view your company through the eyes of a prospective buyer. Potential buyers will pay a multiple of your cash flow (typically earnings before interest, taxes, depreciation, and amortization, EBITDA) based on how risky they perceive your business to be. Quite simply, the more risk, the lower the multiple. Therefore, the two-pronged goal is to increase your EBITDA while simultaneously minimizing risk in your business.
It is important to simultaneously develop a financial plan. For many entrepreneurs, the business is their retirement nest egg, so integrating business and personal planning will help determine the sale price needed to fund a retirement lifestyle. This approach will also help the entrepreneur map the best course of action to reach their target valuation.
Bullet-proof your business model
Structure the business so that it’s independent of you. Businesses that are dependent on the owner become very risky investments once that individual departs. To put this into practice, appoint or hire someone to operate the daily business activities and learn how to govern the company from a distance.
Once an individual is identified to manage the business’s day-to-day operations, make sure that he and other key employees will stay with the business. Key employees may be vital to the deal, so ensure that noncompete agreements are in place. Also, consider setting up nonqualified deferred compensation plans for those key employees with vesting schedules which will entice them to stay with new ownership after the sale.
Next, document systems and procedures. A “how-to” instruction manual in running your business can’t be in your head. The business needs to be able to run like a well-oiled machine immediately after you’re out of the picture.
Organize your business’s financial house
Avoid overconcentration by making a point to maintain a diversified customer base. When a company relies on a significant percentage of its revenues from one customer, it becomes a very risky business to buyers.
Ensure that financial statements have been reviewed and audited and are readily available. All potential buyers will want to see at least three years of statements—and they must be clear and easy to understand. As the seller, you will want to back out any “lifestyle” spending that had been run through the company, such as car payments, meals and entertainment, or vacation costs. Removing these expenses will help to increase your EBITDA.
It is also important to have a plan to address unpredictable roadblocks such as lawsuits, HR challenges, or accounting issues, which could translate to a lower multiple.
Assemble your team
Before weighing any offers or making it known that you’re in the market to sell, build a team that can guide you through this process. You will need CPAs, financial planners, attorneys, and investment bankers in your corner as you prepare to sell.
It’s important to put trust and control in the hands of one quarterback who has experience with exit planning—and this person cannot be you. For most entrepreneurs, this is the first time selling a business, so recruiting a seasoned adviser is vital to overall success. Select an adviser who will align their best interest with yours. The anointed quarterback will act as the intermediary to ensure that the rest of your squad is synchronized.
Selling your business can take nearly as much time and effort as building it. Above all, remember that you cannot begin the planning process too early—minimum lead time to adequately plan is three to five years. Ideally, you start thinking about your business exit strategy the day your doors open so that you can properly groom it for sale.
Mark Tepper, CFP, is president and founder of Strategic Wealth Partners in Seven Hills, Ohio, a comprehensive wealth-management firm that specializes in planning for small-business owners. Tepper has conducted extensive research with entrepreneurs, particularly examining the challenges they face in planning their exit and personal finances.