Many business owners get caught up in the daily grind and don’t start considering an exit strategy until it’s too late, says Tim McDaniel, CPA/ABV, ASA, CBA, director of business valuation services at Rea & Associates.
“I’ve been trying to encourage owners to think of the business as an investment, because it is likely the biggest investment they have. Studies show that over 50 percent of the net worth of business owners is related to their ownership,” McDaniel says.
Smart Business spoke with McDaniel about what business owners can do to maximize the value of their business and increase the likelihood that they will have a more successful exit.
Is the problem that owners look at running the business as a job?
It could be that, or it could be that they look at the business as a piggybank to support their lifestyle. But they don’t treat it like an investment and try to maximize their return. You should look at your business like a 401(k), real estate or any other investment you own. If your business is worth $1 million and you grow it by 10 percent a year for the next 10 years, it can more than double in value. That could have a big impact on your retirement.
What needs to be considered in planning an exit strategy?
The first step is to have a professional valuation. It’s pretty simple — the value of your business increases with increased cash flow and lower risk. But knowing what it’s worth is an important part of the planning process.
The biggest mistake people make is assuming a company is worth $5 million when it’s only worth $2 million. Then their retirement plans are based on a faulty premise of value.
Once you determine the value, you need to think about how you want to exit the business. There are four major ways:
- Selling. It could be to a synergistic buyer that is bigger and can pay more because it can eliminate jobs. Or you can sell to a financial buyer or to your employees through an Employee Stock Option Plan.
- Gifting to relatives.
- Keeping the business, but hiring someone to run it.
- Liquidating the business.
More and more owners are retaining their businesses and hiring professional management. They might stay involved by serving on the board of directors. That’s because they’d rather keep ownership and collect dividends instead of placing money from a sale into an investment or CD with a low return.
The route you take will be based on your retirement needs and what you want your legacy to be. If you want the company to continue as-is, you’ll likely accept less in a sale because you don’t want to sell to a competitor that comes in and fires everyone.
Sit down and think about what’s important to you, whether it’s having a large amount of cash, or having your children or employees running the business.
If you are considering gifting it to children, don’t assume the next generation has the desire or talent to drive the business. Take a proper assessment of how well the next generation will do.
How long in advance of an exit do you need to start planning?
It’s a good idea to start three to five years out. But if you have an exit plan in place at all times, you can be prepared for any situation and take advantage of a favorable marketplace. If your goal is to sell in five years and the economy and mergers and acquisition market are doing well in two years, you might want to sell earlier.
The biggest challenge owners have with succession planning is giving up control. But the reality is that you are going to exit the business, whether it happens based on plans or life events. If you want to exit on your own terms, you should understand all of the available options and the value of each one. ●
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