AMI Institute, LLC

EXIT STRATEGIES

ContentsINTRODUCTION..............................................................................................................2

THE PLANNING PROCESS..............................................................................................6

GETTING YOUR COMPANY READY FOR SALE...........................................................10

VALUATION OF BUSINESSES.......................................................................................13

EXIT STRATEGIES.........................................................................................................17

SELLING YOUR BUSINESS...........................................................................................19

PLANNING FOR SUCCESSION......................................................................................23

SELLING TO EMPLOYEES (ESOP)................................................................................26

DISSOLUTION OF PARTNERSHIP.................................................................................26

ENDNOTES ………………………………………………………………………………….. 27

© Copyright 2000-2017 by David Regenbaum, AMI Institute, LLC. Houston, Texas. All rights reserved. Reproduction in whole or in part is not permitted without express written permission.

This publication is designed to provide authoritative information regarding the subject matter covered. It is provided with the understanding that the author is not engaged in rendering legal, accounting or other professional services. If legal or other expert advice or assistance is required, the services of a competent professional should be sought.

Page 1

INTRODUCTION

If you are one of the very few entrepreneurs

that has a formal business plan it probably

does not include a section on exit strategies.

Entrepreneurs seldom place importance on

their exit strategy when starting a business.

Unlike investors, business owners are

focused on running (and growing) the

company. Some investors are interested in

income, but the ultimate goal of most

investors is return of their investment and a

healthy profit. This requires a well-

conceived and executed exit strategy.

If the business plan is the road map for your business, the exit strategy is the destination.

To be successful in your business you have

had to put in tremendous amounts of time,

effort and hard work. At some time you are

going to start thinking about getting out of

the business. It may be that you are thinking

of retirement, or you may receive an offer to

purchase your business, or you may want to

slow down and smell the roses, or you may

just be burnt out and want to cash in on your

years of hard work. The reason is

unimportant, knowing your options and

strategizing your exit is essential if you want

to receive the most from your exit.

Even if you think you are many years away

from selling out, consider what your heirs

and employees would have to do if you died

unexpectedly. If you have not planned an

exit strategy your heirs may have no choice

but to liquidate the business and sell off the

assets piecemeal, getting nothing for the

goodwill that you built up over the years.

Your employees who may have been with

you for years may suddenly find themselves

unemployed.

John M. Leonetti, author of Exiting Your

Business, Protecting Your Wealth, says:1

“The exit is a process, not an event. This process takes time and will impact a lot of people, so owners should put a lot of thought and analysis into it to gain clarity about what the right decision is. In most cases, if the owner makes the investment of time, they will be rewarded for it.”

Planning your exit well in advance can make

a significant difference to the success of

your exit strategy. Don’t wait until you are

forced to make hasty decisions. Sometimes

the need to make these decisions occurs

unexpectedly, such as in the case of an

incapacitating illness or the death of the

CEO or of a partner or co-owner. Some

aspects of an exit strategy may take years to

achieve and the sooner you start planning

the greater your chance of success.

Page 2

Jerome A. Katz, associate director of the

Jefferson Smufit Center for Entrepreneurial

Studies at Saint Louis University, said:2

“As a company founder, you might not think of yourself as having a career path – but you do. And the path you’re on can tell you a lot about whether you’re likely to leave your company gracefully when the time comes to call it quits.”

Katz described four major types of

entrepreneurial career paths including the

endgame strategies of each:

1. Growth Entrepreneurs. They are the

founders who follow the bigger-is-better

model of large business. They measure

their success by number of employees or

sales figures or market share and are

unlikely to have an exit plan.

2. Habitual Entrepreneurs. They start many

businesses and often run several at the

same time. They measure their success

by how well each business meets the

goals they’ve set for themselves. They

are even less likely to have an exit

strategy, as there are always more ideas

to try out.

3. Harvest Entrepreneur. They run their

company so that they’re ready to sell and

leave their company. They’re interested

in a strong balance sheet, sizable market

share, proprietary processes, and

developing a team able to take over in

their absence. They generally have a

clearly defined exit strategy and have

more of an “investor” approach to

business than the typical entrepreneur.

4. Spiral or Helical Entrepreneurs. They

have spurts of growth and periods of

intentional stagnation driven by personal

or family needs. Their endgame strategy

is probably to scale down their business.

According to Katz the reason why

entrepreneurs don’t develop exit strategies is

that no amount of golf, travel, or family can

replace the adrenaline rush of running your

own business. When George Eastman, the

founder of Eastman Kodak, retired he

committed suicide leaving a brief note: “My

work is done. Why wait?”

At some point in time your focus may

change from wealth accumulation to wealth

preservation. Your exit strategy needs to

include considerations that are personal to

you. Cashing out may not be appropriate for

everyone. Some of the questions that you

need to answer include –

How will you invest the proceeds?

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Will you receive a greater return on your

investment than you receive out of your

business?

What will you do with yourself?

How will your retirement affect your life

style?

Will you enjoy the new environment?

Sometimes you must be careful what you

wish for – you may get it! Or as a popular

Country and Western song title puts it:

Thank God for unanswered prayers.

The decision of when to cash out, how to

cash out, and, more importantly, if one

should cash out, is extremely subjective and

personal. Every business owner must

evaluate his or her own personal needs and

desires and plan accordingly. Even if you

are one of those people that loves what they

do and wants to continue doing it to their

dying day, developing an exit plan for that

day is important.

An exit strategy is essential if you wish to

protect the value of your business. There are

several valid reasons for selling your

business. Some of the primary reasons for

selling are –

1. Diversification. For many business

owners, their business represents their

largest single investment. By selling

the business the owners reduce their

personal risk. This also allows them to

achieve some liquidity and to diversify

their investments.

2. Estate Planning. By selling the

business the owner establishes a true

value for estate purposes. It may also

provide the liquidity for an equitable

distribution of the estate, particularly if

all the heirs do not participate in the

business. Selling the business after the

death of the founder places the sellers at

a distinct disadvantage.

3. Expansion by merger. The amount of

capital required to start and expand a

service business is generally not

significant. The need for expansion by

merger has more to do with personal

and lifestyle issues. It is lonely at the

top of a small company. It creates

tremendous pressure, with little or no

opportunity to take time off, and the

loss of a major contract could have

significant adverse results. Selling to or

merging with another firm can solve

some of these concerns.

4. Continuity and succession. The

founder of the business is frequently not

able to provide for long-term Page 4

management and continuity of the

business. Continuity can be achieved

by selling a portion of the business to

employees by way of stock options or

an ESOP. Or, depending on

circumstances, the founder can groom

his/her heirs to succeed him/her in the

business.

5. The right time. Sometimes it is just

plain and simply the right time to sell.

“When it stops being fun, that’s the

number one sign that it’s time to sell

the business,” says Barry Merkin,

clinical professor of entrepreneurship at

Northwestern University’s Kellog

Graduate School of Management in

Evanston, Illinois. But he warns that

once you decide to sell your business

you start focusing on selling and

neglect to continue building the

business and keeping it healthy. This

could have an extremely detrimental

effect on the ultimate value of the

business.

Page 5

THE PLANNING PROCESS

Most entrepreneurs will only implement an

exit strategy once or twice in their lifetimes.

They will have little or no experience in

negotiating the sale of a business. The

buyer, on the other hand, may be

experienced in mergers and acquisitions.

This places the entrepreneur at a distinct

disadvantage. It is therefore advisable that

they seek competent guidance and advice

from professionals who are experienced in

the particular exit strategy that the

entrepreneur is planning to pursue.

The planning process for an exit strategy

should commence with deciding on the right

kind of entity when going into business.

The most common forms of business entities

are –

Sole proprietorship – This is the most

common form of business organization. It is

easy and inexpensive to form and gives the

owner complete control over all facets of the

business. The major drawback is that the

owner is liable for all the losses and

financial obligations of the business. All

profits and losses are ‘passed through’ to the

owner for tax purposes.

Partnership - Two or more people get

together to start a business and agree to

share the profits and losses. Each of the

partners is personally liable for all the losses

and financial obligations of the business.

All profits and losses are ‘passed through’ to

the partners in proportion to their respective

interests for tax purposes.

Corporation – This is a legal entity that is

created for the conduct of the business. It is

a separate entity from the individuals that

created it. It has separate legal liability and

can be taxed separately. The primary

benefit of a corporation is the limitation of

liability. There is obviously a cost

associated with its creation and additional

record keeping is required. Double taxation

can be avoided by using an S corporation

that allows income and losses to ‘pass

through’ much like a partnership.

Limited Liability Company (LLC) – The

limited liability company allows owners to

take advantage of the benefits of both the

corporation and the partnership forms of

business. The owners are shielded from

personal liability and income and losses pass

through to the owners.

The two primary considerations are limited

liability and tax. There are several options

for limiting liability. These include “C”

corporations, “S” corporations, Limited

Liability Company, Limited Liability

Page 6

Partnership, etc. The type of entity selected

can have significant tax advantages and

disadvantages. The cost of incorporation

and the additional record keeping should not

be deterrents to the most important goal of

protecting yourself from unnecessary

liability.

CASE STUDY3

Because of potential liability claims against

your corporate entity, a purchaser may

prefer to buy the business of the corporation

as opposed to your stock in the corporation.

If this occurs, the purchase price is paid to

the corporation. If the corporation is not a

“pass through” entity such as an “S”

corporation or an LLC, the corporation will

be subject to tax on the purchase price and

you will be subject to tax on the distribution

of the purchase price from the corporation to

you. This potential double taxation can be

eliminated by initially creating a “pass

through” entity or can potentially be reduced

by converting your “C” corporation to a

pass-through entity such as an “S”

corporation. Section 1374 of the Internal

Revenue Code provides for a built-in gains

tax for certain dispositions of property

within the first ten years following an S

election by a company with retained C

corporate earnings and profits.

A corporation is also more flexible. It

allows you to expand by bringing in

additional shareholders (partners) without

disrupting the business entity by issuing

additional stock. When disposing of the

business it is easier to transfer the stock than

to transfer the assets of the business and on

the death of the owner the stock can more

easily be distributed to the heirs.

Discuss your options with your attorney and

CPA. Select the type of entity that best suits

your business plan and gives you the most

favorable tax advantages while you are in

the business as well as when you finally

decide to get out of business.

The planning process should be designed to

maximize the value of your company before

converting it to cash, and to minimize the

amount of time consumed in the process.

The following is a list of some of the steps

to be considered:

1. Decide or agree to sell/terminate the

business/corporation. If there is more

than one owner, the corporate documents

or partnership agreement should contain

provisions relating to disposition or

termination of the relationship. It is best

to agree on the terms of dissolution at

the start of the business relationship and

Page 7

to document them. If disputes arise, an

effort should be made to settle quickly.

2. Designate a leader and organize a team.

Authority and roles should be clearly

defined. If there is only one owner, s/he

may initially be the only team member.

3. Engage professionals as team members.

Consult the company’s legal counsel,

CPA, business broker, and valuation

expert. Professional advice will improve

the process and result.

4. Perform a thorough review of the

business and identify problem areas.

Establish a list and endeavor to

eliminate/minimize any problem areas.

5. Prepare a list of contracts. The list should

contain relevant details for each

contract:

Identity of parties to the contract

Significant terms of contract

Can contract be assigned?

6. Prepare a list of other assets. Perform a

physical inventory of assets. The

inventory will assist in establishing the

value of the business.

7. Perform a valuation of the business. It is

difficult to make prudent decisions

without knowing the market value of the

business and its assets.

8. Prepare a detailed plan and assign

responsibilities. In developing the plan

care must be taken to consider all

aspects of the proposed transaction,

including potential tax implications.

9. Develop a schedule for implementation.

A schedule is necessary to provide the

ability to measure progress.

10. Implement plan. Finalize terms of

disposition.

11. Release announcements and notices. At

some point interested parties need to

know what is happening: employees,

vendors, suppliers, professional service

providers, market.

12. Conclude and transfer contract

obligations. This process may require the

consent of the contracting parties, and

may involve further negotiation. Office,

car and equipment leases need to be

reviewed. The timing and termination of

insurance and benefit plans are

important to all involved.

Page 8

13. Dispose of or transfer assets. This can

have significant tax implications.

14. Guarantees. Negotiate release of any

guarantees signed by you.

15. Termination of your involvement. The

timing of this step is very important and

may be part of the negotiations to sell.

Part of the purchase price may be

dependent on the success of the transfer

and transition and may include an

employment agreement.

If you have sold the business and retained

the corporate shell, the following additional

steps need to be taken –

16. Settle accounts payable and Debt

obligations.

17. Prepare final financial statements and tax

returns. Final financial statements are

important to establish the tax

implications for assets, gains, and losses

conveyed to the owners or other

involved parties.

18. File final returns. File final returns of

payroll, unemployment insurance, and

other State and Federal agencies as

necessary to indicate that the business is

closed.

19. File Articles of Dissolution.

20. Close bank accounts.

21. Store business records.

The planning, process and timing of events

and tasks must be tailored to the individual

company and to the circumstances of the

particular exit strategy employed. Each

situation is unique and the problems or

procedures that exist or develop are unique

to the circumstances.

Page 9

GETTING YOUR COMPANY READY

FOR SALE

In an article published in Inc. Magazine4

Colin Gabriel, author of How to Sell Your

Business – And Get What You Want! (Gwent

Press, 1998), stated: “Getting your company

ready to sell means sprucing up operations

and mimicking the professional standards of

public companies – first-class financial

statements, budgets, business plans, and

management that’s not dependent on one

person.” He went on to say that at the very

least, running your business as if you were

preparing to sell it will improve your

management practices and increase the

value of your company.

Add Value Before the Sale. There are

many things that you can do to enhance the

value of your business before the sale.

Unfortunately, most of them take time to

implement and if you are in a hurry to sell

you may not be able to add much value.

Enhancing your financial statements can

take three to five years. This is one more

reason to plan your exit strategy well in

advance. Taking the time to prepare the

business for sale will also facilitate the

transaction, thereby also enhancing value.

Financial Statements are the best indicator

of future performance. Audited financial

statements reassure buyers and enhance their

comfort level. The cleaner your financial

statements are, the less you must explain,

the more comfortable the buyer is, the easier

it is for you to sell, and for a buyer to buy,

your business.

Discuss the preparation of financial

statements for the purpose of sale with your

accountant. It may be possible to modify

your accounting procedures to your

advantage.

Even if you have worked diligently to

improve your financial statement in the prior

years, it may still be necessary to recast your

financial statements before presenting them

to the buyer. If you do so make sure that any

changes to the actual historical statements

are carefully documented and disclosed so

that the buyer recognizes that you are not

trying to cover up anything.

Improve your Assets. Dispose of any assets

that are not productive. This includes assets

that are owned by the business, but are

primarily for your personal use. If you want

to retain such assets now is the time to buy

them from the business. Examples of assets

you may want to retain are your “company”

car and real estate owned by the business.

You can own the real estate as an investment

and the business can continue to lease the

Page 10

real estate from you giving you a future

income stream.

Make sure all the equipment is in good

working order and condition. A buyer will

not want to have to spend money on

equipment shortly after buying the business.

It is also important that the “curb appeal” of

your business is attractive to the potential

buyer.

Reduce your Liabilities. Make every effort

to settle outstanding lawsuits, tax liabilities

and insurance claims. Even if the buyer

purchases the business and not the corporate

entity, these types of liabilities (real or

contingent) adversely affect the buyer’s

comfort level.

On a personal note, you need to review any

personal guarantees that you may have

given for the corporation and endeavor to

obtain releases.

Improve your Income Statement.

Profitability is the most important factor

buyers look for in the purchase of your

business. Many sellers have their

accountants recast their financial statements

to reflect the way the business will look with

new owners. You will still need to disclose

your audited financial statements and tax

returns and will then have to explain the

changes you’ve made. This sometimes

makes the buyer nervous and places you at a

distinct disadvantage. It is generally best to

start improving your financial statements at

least three years before selling so that you in

fact clean up the business itself and not just

the financial statements.

Essentially, you need to show the highest

possible EBIDTA (earnings before interest,

depreciation, taxes and amortization). To do

this start with your revenue. Examine all

potential sources of revenue and make every

effort to increase the total revenue. Are there

any sources of revenue that you have not

fully pursued?

Next examine your expenses and see if you

can reduce or eliminate non-essential

expenses. This may be the time to drop

some of the perks your business provides to

you and members of your family. Work with

your accountant to see whether you can

capitalize some of the expenses.

Contracts may represent your company’s

principal asset. Are they assumable? If the

buyer wishes to buy the business as opposed

to the corporate entity, will you be able to

assign the contracts to the buyer? If your

present contract doesn’t include a provision

allowing you to assign the contract in the

event of a sale of your business you should

endeavor to include such a provision in

future contracts. Your ability to assign the Page 11

contract would not be an issue if the buyer

buys the stock in your corporation as the

contract is in the name of the corporation,

unless there is some provision in your

contract affecting your rights in the contract

if you sell a majority of the stock in the

corporation.

Other contracts may be affected by the sale

of your business. For example, your lease

may contain provisions relating to the sale

of your business or a majority of the stock in

the corporate entity. Check your rights and

obligations under the lease. If you

renegotiate your lease during this time, it

would be preferable to negotiate a short

lease with options rather than a long lease.

This would give the buyer greater flexibility.

If you sell the business (not the

corporation), it would generally be in your

best interests to arrange for your landlord to

enter into a new lease with the buyer rather

than you being authorized to sub-let the

premises to the buyer. With a sub-lease you

would remain liable to the landlord in the

event of the buyer defaulting.

Personnel. It may be advisable to discuss

your plans with key employees. Having a

stable workforce will ensure a smooth

transition and bring added value to the sale

Procedures Manuals. Written manual

containing your business’ policies and

procedures add credibility and value to your

business. They reflect the depth of

management and demonstrate that the

business is not solely dependent on the

owner.

A Business Plan also demonstrates the

depth of management. It is very useful as a

selling tool as it generally describes the

business and its future potential. Some

brokers prepare a selling memorandum to

describe the business for sale. A selling

memorandum signals to your employees,

customers and competition, your intention to

sell. This could adversely affect your

business, whereas a business plan can

achieve the same purpose without causing

an adverse reaction. On the contrary, a

business plan shows continuity and therefore

can have a positive connotation.

Corporate Records. Update corporate

records including minute books. Make sure

all required documentation is current and

readily available. While this may not be

important to you, the buyer’s attorney will

certainly want to inspect them.

Page 12

VALUATION OF BUSINESSES

When considering retirement and possible

exit strategies, knowing the value of your

business is invaluable. How do you

determine what your business is worth?

Many business owners think that they are

the best judges of the value of their business.

However, if they are wrong it can be a very

costly mistake. If they are selling they can

turn away a potential buyer by asking too

much, or receive less than the business is

worth by asking too little. If they are

involved with tax or estate planning and

appraise the business incorrectly they can

face significant tax implications.

An appraisal of the value of your business

that is supported by an independent third

party expert can be a very useful tool in your

strategic planning. As part of the process the

appraiser will provide a valuation report

showing how they arrived at the value. Even

though most valuations will appraise the

business as a going concern, there can be

considerable variations in the value of the

business depending on the purpose of the

appraisal –

For tax purposes, the best valuation is

one that is as low as possible to

minimize tax liability.

For sale purposes the seller will want to

document the highest possible value.

The buyer will want the lowest possible

price. The value will differ if a

controlling interest as opposed to a

minority interest is being sold.

For financing purposes bankers will

look at the value that will be obtained on

liquidation of the business as security for

a loan.

For litigation purposes the value will

be influenced by what you are trying to

prove.

Caution:

If you do have a professional appraisal

prepared for the purpose of a prospective

sale and then decide not to sell your

business, you should destroy the appraisal.

You do not want the IRS to use the appraisal

prepared for the sale of your business for

calculating estate or gift tax.

The three most common methods of

determining the value of a business are –

Rule of thumb. Applying a multiple to

the annual revenue of the business to

determine the base price that is then

Page 13

adjusted by negotiation. Negotiation

tends to focus on the number of the

multiple.

EBITDA. EBITDA is the earnings of

the business before interest, tax,

depreciation and amortization. The

EBITDA is then multiplied by a factor to

determine the price. This method is

similar to the rule of thumb, but is based

on the EBITDA instead of gross

revenue. After agreeing on the EBITDA

negotiation is again based on the

multiplier.

Discounted cash flow. Revenue

projections and operating profits are

discounted to determine the price.

Negotiations generally focus on the level

of risk that the business faces resulting

in the discount being adjusted.

No two businesses are exactly alike nor do

all sellers and buyers negotiate in the same

manner. It is therefore difficult to know

what a particular business will sell for.

These formulas are not accurate and do not

truly reflect the value of your business. They

should be used only as indicators of value

for a typical business in your industry and

no more. Even with a full professional

valuation it should be remembered that the

only true value is what a willing buyer,

having the necessary resources, will pay a

willing seller, both being adequately

informed of the relevant facts and neither

being compelled to buy or sell.

The most common approach to valuing a

small business is to determine the

“normalized” EBIDTA (earnings before

interest, depreciation, tax and amortization)

and apply a multiple to the earnings.

The actual earnings for the preceding three

to five years is the starting point for

calculating the “normalized” EBITDTA of

the business. Starting the process by

enhancing the business’ earnings three to

five years prior to the intended sale will

improve your prospects for obtaining the

highest possible value for the business.

Value of Physical Assets

Generally speaking, the value of the

physical assets required to operate the

business, including the office furniture and

equipment, and computers and related

software, are not a major factor in the

valuation of the business and are included in

the calculated value.

The calculated value generally excludes

cash, receivables, payables, and the

Page 14

assumption of any liabilities. To the extent

that any of these items are included in the

sale, the price would be adjusted

accordingly.

Size as a Factor

The primary objective of most prospective

buyers is generally continuation (and

expansion) of the revenue stream. In a small

one-person business, the company is that

person and if s/he leaves the chances of

continuity and expansion of the revenues are

significantly reduced. When prospective

customers call they’re calling the individual

not the company and if the individual left,

the company would cease to exist. This is a

significant limiting factor in the sale of any

personalized service business.

In an article entitled Making Your Company

Sellable published in Inc. Magazine,5 author

Jill Andresky Fraser quoted several business

brokers who agreed that selling the one or

two-person small personal service business

falls “somewhere between incredibly tough

and impossible.”

The options for the very small-personalized

service business are limited. One option is to

merge with another complimentary company

to create a larger corporate identity that

would become more saleable. Each of the

merging entities acquires stock in the new

venture with little or no money changing

hands.

Another possible option that may be

available to the small business in some

markets is to sell to a larger company. These

sales generally involve an extended buy-out.

A modest down payment is paid with the

balance payable over an extended time.

Generally, these transactions are tied to a

transition period during which the seller is

employed by the buyer and is expected to

transfer his/her skills and marketing contacts

to the buyer. The buyer sometimes links

payment of the balance of the purchase price

to the success of the business during this

transition period.

In the article Making Your Company

Sellable author Jill Andresky Fraser stated:

“Owners of very small companies or of start-ups need to take particular care to make sure that their company has an identity in the marketplace that is separate from their own. Although that may seem like an irrelevant distinction, it is an important one for any company trying to convince a prospective buyer that the business could survive the sale.”

Jill Andresky Fraser listed five ways to

enhance the salability of your company:

Page 15

1. Cross the $1 million mark. Brokers

agree that companies have a far easier

time attracting buyers once they pass the

$1 million mark in revenues.

2. Build a staff of five or more. Statistics

show that the hardest businesses to sell

are those with less than five employees.

In larger companies it is important to

demonstrate employee loyalty,

qualifications, experience, length of

tenure, and the existence of non-compete

agreements. This will show the depth of

the organization.

3. Create corporate identity. The goal is

to establish a corporate brand that

distinguishes you from the company.

Everything from a distinctive logo to a

successful web site would help.

4. Accumulate assets. A business that

consists of you, your brain, and your

network of contacts will never sell.

5. Build a board of directors. If that

seems a little excessive given your

company’s size or growth stage, think

again. There’s no better way to signal to

the outside world that you have a

serious, growth-oriented company than

to set up a strong board.

National firms sometimes rank the

Companies they purchase into two basic

categories: Platform and Tuck-under.

Platform companies are usually the

dominant company in their market and the

tuck-under companies are smaller

companies that are tucked under the

platform company. The multiple paid for

platform companies is considerably higher

than the multiple for tuck-under companies.

In certain select markets the small business

may be “tucked under” by a larger business

that in turn was acquired by a public

company listed on a stock exchange. The

seller generally sells 80% of the company

for cash or stock in the listed company. The

seller sometimes remains employed by the

acquiring company for a specified period

and can thereafter sell the remaining 20%.

It is financially beneficial to be the platform

business and then acquire tuck under

businesses before selling the remaining

20%.

Page 16

EXIT STRATEGIES

The most common exit strategies to be

considered are –

IPO - Selling shares of the company to

the public, resulting in the shares being

traded on a stock exchange.

The advantages of an IPO include

conversion to cash for investors, ability

to raise large amounts of capital, major

shareholders are usually able to retain

control, high potential return, and having

a market for trading of shares.

For an IPO to be considered, let alone be

successful, the company must have

significant growth and profit potential. It

is a very costly process with an uncertain

outcome and opens the company to

public reporting and scrutiny. Major

shareholders may be limited as to how

much, when, and how they can sell

stock.

ROLL-UP – Most small businesses are

too small to contemplate an IPO on their

own. In a roll-up several companies

group together for the purpose of an

IPO. This process has all the advantages

and disadvantages of an IPO, plus a few

additional significant challenges. The

ability of the individual companies to

create a leadership team and to integrate

their corporate philosophies and cultures

being two of the most difficult

challenges to overcome.

ACQUISITION – Business bought

outright by another existing company.

The purchase price may be paid in cash

or stock or a combination of both. The

selling owner may negotiate a

management contract to facilitate the

transition. The difficulty is finding an

appropriate purchaser. Usually the

corporate identity of the acquired

company will disappear.

SALE – Business bought by other

individuals. If a suitable purchaser can

be found, the seller will generally

receive cash. Some of the purchase price

may be paid at a future date and be

subject to sustained performance of the

business. Management of the business

will transfer to the purchaser.

MERGER – Join with an existing

company. Resources are combined and

current management may be integrated.

New partners or bosses may result in

less control. Little or no cash may be

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received. Potential clash of corporate

personalities/ philosophies.

BUY-OUT – One or more stockholders

buy out the other/s. Seller generally

receives cash and the other owner/s

remain in control of the business. Can be

a simple transaction with no due

diligence investigations being necessary

and few, if any, representations being

required.

BUY-SELL – This form of agreement is

generally entered into between partners

or co-owners of a company. An

innovative form of this agreement is

between the Owners of two competing

companies who agree that when either

wishes to sell, they will sell to the other

at a purchase price based on an agreed

formula. This is a particularly useful exit

strategy for company owners on their

death or disability when an ESOP or

succession by family members is

impractical.

ESOP – Employees stock option

purchase. The employees purchase the

business. Continuity may be simplified,

but availability of funds and lack of

entrepreneurial ability may be problems.

FRANCHISE – Sell business concept to

others to replicate. The advantages are

retention of current management and

opportunity for large-scale growth.

Franchising is a complex legal process

and the rate of return from small

businesses may not be adequate to

support franchising.

SUCCESSION – Pass the business on

to children or other family members on

death or retirement.

LIQUIDATION – Liquidate the

business and sell the assets. The owner’s

goodwill that s/he spent many years to

build is usually lost. Generally,

liquidating the business will result in the

lowest yield to the owners.

BANKRUPTCY – If all else fails and

the business has substantial debts filing

for bankruptcy may be the only solution.

The most effective exit plans take into

account the nature of your business, the

personnel, and your personal goals. All of

these may change and it is therefore

recommended that your exit strategy be

reviewed from time to time to determine if it

still meets your personal goals.

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SELLING YOUR BUSINESS

Selling your company is the culmination of

your years of efforts to build a sound

business. It is the final measure of your

success and it is therefore very important

that you formulate your plan carefully. Use

the help of professionals and take the time to

negotiate the best price and terms for you.

INITIAL ISSUES – Before you begin the

process of selling your business you should

consider the following –

Defining your priorities – What aspects of

the sale are most important to you?

What do you want for yourself, and your

employees, in the future?

How much of your self-esteem is tied up

in owning and running your company?

Do you want to sell the entire company

or would you sell a controlling interest

and retain a minority holding as an

investment?

Would you be prepared to continue your

employment with the company at an

agreed salary or do you wish to retire?

If you wish to continue working with the

company, could you report to someone

else?

If you wish to retire, will the amount you

receive be adequate to meet your needs?

Do you want an all cash deal or would

you accept some stock in the acquiring

company?

Are you prepared to finance a portion of

the purchase price?

Is there some minimum price (say, a

round number like one million dollars)

that you must get to be happy?

As with most things in life, you will have to

make some compromises. You need to

evaluate what you really need from the sale

to satisfy you and then prepare a list of your

realistic priorities, leaving yourself some

negotiating room.

Timing your decision – What’s the best

time to sell your business, and how long will

it take?

Choosing professionals – What kind of

professional help will you need, and how

will you find it?

At a minimum, you will need to consult

your attorney and accountant. There is a

myriad of legal and financial issues involved

in the sale of a business about which the

average entrepreneur has no knowledge or

experience. If the sales contract is not

worded correctly you may not get all your

money and could be exposed to significant

liabilities. There are numerous tax

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consequences and filings that follow the sale

which if not properly considered and

followed could be adverse to your best

interests.

Another professional that you should

consider is a business broker. Do you have

all of the time necessary to devote to the

negotiations? You need to ensure that your

business runs very smoothly while

negotiating the sale. Will time focused on

brokering and negotiating the sale have an

adverse effect on your business at a time

when any problems can have a negative

effect on delicate pending negotiations?

Other professional members of your selling

team include the business appraiser and

tax expert. The business appraiser will

provide you with an impartial documented

expert opinion of the value of your business.

This will provide you with a yardstick to

determine if your emotional mental value is

accurate. Taxation is and is becoming more

complicated. The services of a tax

professional on your team can avoid many

of the pitfalls associated with tax. It is

possible that your CPA can perform the

functions of the appraisal and guide you

through the potential tax pitfalls.

And finally, a banker or other source of

financing may be an asset on your team.

Many potential purchasers do not have the

available funds to acquire your company.

Having a source of funding that is familiar

with your company will facilitate the sale

and at a price that will generally be more

advantageous for you.

A word of caution needs to be expressed.

Be careful that the consultants you employ

don’t try to sell you their products/services

at your expense. Use common sense and

always do what’s best for you.

For Sale by Owner. An article in the June

2000 Inc. magazine highlighted a do-it-

yourself test for company owners who

wished to sell their company by themselves.6

The author raised four questions:

1. Do you have a fairly good sense of how

much your company is worth? If not, it

pays either to get an independent

appraisal or to rely on a business broker

or investment banker. Otherwise, you

risk underpricing the company or

discouraging potential buyers by pricing

it too high.

2. Can you draw up a list of likely

buyers? Your prospects might be

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competitors, strategic partners, or your

employees. Do you personally want to

approach them about the sale of your

business? What adverse situations may

arise if they know you want to sell? A

third party professional business broker

can approach them to determine their

interest in buying a business without

initially disclosing your business

identity. You probably haven’t

considered all the options available and

are generally better off relying on a

professional.

3. Do you really have the time to do this?

It’s incredibly time-consuming to do the

networking yourself. You have got to

have the internal organization to support

you and continue to run the business in

an efficient and profitable manner. The

important thing is to keep your company

moving forward through the whole

process. If you know in your heart that

you (and your staff) won’t be able to

manage both the sale and the company’s

operations, don’t try to go it alone.

4. Can you do a better job than anyone

else? If you’re articulate, passionate

about your company, and – above all –

not self-conscious about pitching it for

sale, then the answer is probably yes.

But if you suspect that your emotions or

anxieties could get in the way, step

aside. Even if you decide to negotiate the

sale yourself it is advisable to get lots of

coaching from the professionals. In

situations where the seller is likely to

remain with the company as a consultant

or employee it is usually better to have

an impartial third party negotiate the sale

for the seller to minimize any built-up

antagonism that may result from hard

negotiations.

Legal/ethical considerations – Does your

position as a partner, shareholder, officer, or

director of the business affect your ability to

sell out? How careful must you be in

describing your business and disclosing

problems to potential purchasers?

It is essential that as the seller you be

completely truthful and candid with the

potential purchaser. Failure to do so will

generally result in a costly and time-

consuming lawsuit. Dealing fairly with the

purchaser is not only your moral obligation,

it is also a legal requirement.

You will obviously sell the purchaser on all

the positive aspects of the business, but you

also have an obligation to disclose any

potential problems. If possible, present

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possible solutions to the problems to

alleviate their effect on the negotiations.

Non-disclosure of facts that may influence

the purchaser could be regarded as fraud or

at best as misrepresentations.

Misrepresentations include false statements

as well as non-disclosure of adverse

information that you knew or should have

known about. In any event material

misrepresentations can become the grounds

for a lawsuit if the purchaser reasonably

relied on the information or would have

come to a different conclusion had s/he

known all the facts.

Responsibilities to Co-Owners – Co-

Owners, whether co-shareholders or partners

are required to act with the utmost good

faith toward each other. Co-owners have a

fiduciary obligation to each other. This

means that a co-owner selling his interest

may not seek to benefit himself at the

expense of his co-owner/s. In addition,

officers of a corporation have a fiduciary

duty to the corporation and to its

shareholders to act in the best interests of the

corporation.

Buyer considerations – There are a variety

of different types of buyers and most of the

seller’s preparation should focus on what

would make a buyer comfortable. For

example, some buyers will look for

synergies, whereas others will seek

profitability and are not interested in

creating a lasting marriage.

Prerequisites required by a purchaser may

include strong cash flows, $5-$150 million

minimum gross revenues and a minimum 3

years’ profitability at 10%+ of gross

revenues pre-tax profits. Information

required may also include –

Last 3 years’ historical financial

statements, including income statements

and balance sheets.

Projections for current year, plus two

additional years.

Aging of accounts receivable.

Explanation of non-recurring expenses.

Last three years’ tax returns

Information relative to any outstanding

or pending legal disputes.

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PLANNING FOR SUCCESSION

Perpetuating your business through an

orderly succession to family or other

insiders has been described as the ultimate

management challenge. The succession of

ownership and management must be

perceived as a process rather than an event.

Barely 30% of family businesses survive

into the second generation and fewer than

15% into the third. If the business of

succession is not done by process (through

planning), it will be done by crisis (a failure

to plan), with perhaps disastrous results.

In an article published in Inc. Magazine,7

author Donna Fenn quoted Mendy Kwestel,

director of entrepreneurial services at the

New York City office of Grant Thornton, a

national accounting and management-

consulting firm, “(T)he first thing you need

to have is a strategic plan that tells you

where the business is going. That will

determine the type of person you want to

succeed you. Then you ask yourself who

your candidates are.” If your children don’t

make the short list, or are just not interested

in managing your business, you may need to

separate the management and ownership if

the company.

A succession plan should start with a

strategic plan and then consideration must

be given to the two elements of the company

succession:

The transfer of power (management)

The transfer of assets (ownership).

Transferring Power. Managing a transfer

of power while balancing the internal and

external influences of the business is a

juggling act at best. If the illustrious founder

is somewhat less than willing to give up

control and/or the designated successor is

not well prepared to accept it, the transfer

can be a challenge.

Major issues confronting a family business

owner seeking to transfer power to

successors include:

Selecting a successor

Intergenerational conflict.

Selecting a Successor. Frequently this

occurs by default. Usually one member of

the next generation will be more active and

display more interest. The founder is likely

to spend a great deal of time grooming the

successor-apparent. The challenge comes

from trying to deal equitably with the other

members of the family.

Page 23

If one member of the family hasn’t evolved

as the natural successor, it may be advisable

to involve key employees in a transition

team or to bring in an outside CEO.

Involving key employees in a transitional

team may have an added benefit of retaining

them as valuable members of the business.

If there is competition between family

members for the position, dividing the

power between them doesn’t usually work

unless each can head their own distinct

department. Ownership can be divided, but

management needs to be clearly delineated

to minimize conflict.

Quentin J. Fleming, author of “Keep the

Family Baggage out of the Family Business”

(2000, Simon & Schuster) recommends a

three-part succession test: Do successors

have the skills, ability and competence? Do

they have the full authority or can they get

it? Do they want the job? He says that a

“no” answer to any of the questions should

disqualify the candidate.

Intergenerational Conflict. Conflict

between the founder of a family business

and his or her successor is a matter of

degree, it’s normal for some

intergenerational conflict to exist. Experts

in the field highly recommend that the

successor work outside the family business

for a few years to gain business experience

and develop business management skills by

participating in outside business

organizations.

The successor is only one part of the

problem. The founder also needs to prepare

him or herself financially and emotionally

for the transition. The founder could fulfill a

role in the business that s/he enjoys most,

for example, business development, or

public relations. This will enable the

successor to benefit from the founder’s

passion without having the founder interfere

in the day-to day operations of the business.

Another potential area of conflict that needs

to be resolved is at what point does the

founder retire?

As in most interpersonal relationships,

communication skills are essential to the

success of the transition. Even with the best

communication skills conflicts do arise. One

of the best ways to minimize conflict is to

develop a comprehensive strategic plan that

clearly defines the mission of the business as

well as that of the family. Deciding in

advance who has the final say in, for

example, reinvesting profits in new

technologies to build the business or in

paying dividends or bonuses to the founder

Page 24

will reduce the potential conflict and should

be contained in the strategic plan.

The founder’s spouse may also become

embroiled in the conflict thereby

exacerbating an already difficult situation,

particularly if the founder dies unexpectedly

and is not present to referee the conflicts.

Transition Timing. Transition of

management control (power) can take

months or even years, depending on the

wishes and needs of the family and of the

business.

A transition plan or timetable should

initially be drafted to assure continuity of

management, and should be reevaluated

periodically to see if goals are being

achieved. The transfer of power can be

seamless and subtle if good communications

and careful planning are practiced by all

parties to the transaction.

Transferring Assets. Transferring the

assets has significant and extremely

complicated tax implications. Financial

planning and estate planning are closely

aligned and to be effective both need to be

planned well in advance. Because of the

complexity of each of the individual

circumstances, the use of professional

experts is essential to achieve the best

results for the family.

Page 25

SELLING TO EMPLOYEES (ESOP)

Employees are frequently interested in

taking over the company they work for. An

Employee Stock Option Plan (ESOP)

provides tax incentives for employees,

owners and banks to finance partial

employee ownership. Typically, for partial

ownership (30% or less) it may work. For

majority ownership and control it doesn’t.

The primary problem is management

decision making. Some employees think

that they can manage the company better

than the owner. But who will make the

tough decisions that entrepreneurs make as a

matter of course? Employees don’t think

like an entrepreneur and they are not

typically willing to risk everything like an

entrepreneur. Are the employees prepared

to guarantee the bank loans? Probably not.

Distinguish between entrepreneurs who have

a high degree of risk tolerance and

intrapreneurs who may be innovative and

good managers, but don’t have the risk

tolerance.

DISSOLUTION OF PARTNERSHIP

Many small businesses are jointly owned by

two individuals. No matter the legal form of

their relationship, they are partners to all

intents and purposes. What happens when

they decide to go their separate ways?

They may have a buy-sell agreement in

terms of which one of them buys out the

other. The seller generally receives cash and

the other owner remains in control of the

business. This can be a simple transaction

with no due diligence investigations being

necessary and few, if any, representations

being required other than, possibly a non-

compete agreement by the retiring partner.

The difficulties that may arise relate to

which of the partners will remain and the

price to be paid. Jill Andresky Fraser quotes

attorney Joel I. Cherwin, a partner at Boston

law firm Cherwin & Glickman,8 as

recommending an auction that can be

customized to the corporate situation or the

partners’ personalities. “You can decide that

each person walks into the room with a

sealed bid, and the highest one takes it.”

Says Cherwin. “Or, if you both want room

for maneuvering, you can specify that there

will be two or more rounds of bids.” Risk

takers can even opt for Russian roulette. “In

that case,” Cherwin says, “one partner

names a price at which the other partner

decides whether to buy or sell.”

Page 26

This overview of exit strategies is intended to give you some basic ideas and to make you aware

of some of the options available to you. It is not intended to give you legal, accounting, tax or

other professional advice. It is recommended that the services of competent professionals be

sought.

© Copyright, 2000-2017 by DAVID REGENBAUM, AMI INSTITUTE, LLCHOUSTON, TEXAS

Page 27

1

ENDNOTES

Leaving your Business: How to Plan an Exit Strategy for your Small Business. Interview with John M. Leonetti, Quickbooks Resource Center (http://quickbooks.intuit.com/r/business-planning/how-to-plan-an-exit-strategy-for-your-small-business/)

2 ‘Which Track Are You On?’ by Jerome A. Katz, Inc. Magazine, October 01, 1995

3 ‘Finance 101 – You and potential buyers can be at loggerheads when it comes to whether you sell stock or assets.’ by Jill Andresky Fraser, Inc. Magazine, April 1, 2001 (http://www.inc.com/search/22327.html)

4 ‘Selling Your Business’ by Colin Gabriel, Inc. Magazine, November 01, 1998

5 ‘Making Your Company Sellable’ by Jill Andresky Fraser, Inc. Magazine, March 1, 2000

6 ‘Company for sale by owner – or maybe not’ by Jill Andresky Fraser, Inc. Magazine, June 2000 page 129

7 ‘Could Your Kids Run Your Company’ by Donna Fenn, Inc. Magazine, July 1, 1998

8 ‘Selling the Company: When Partners Can’t Agree’ by Jill Andresky Fraser, Inc. Magazine, April 1, 1996

Additional Resources:SBA: Closing Down your Business: https://www.sba.gov/managing-business/closing-down-your-business

Exit Strategies: http://www.businessinsider.com/startup-exits-should-be-positive-and-planned-early-2011-1

Exit Strategies: http://groundfloorpartners.com/exit-strategies-for-small-business-owners/

Exit Strategies: https://www.entrepreneur.com/article/78512

Guide to Selling Your Business (http://www.nvst.com/pnvwhogide.asp)

Selling a Business (http://www.morebusiness.com/running_your_business/financing/sell.brc)

Free value calculator: http://www.valueacompany.com/valuation-calculator/established/1979/sector/Professional-

Services+or+Consultancy/

Family Business: www.familybaggage.com