Many entrepreneurs devote the vast majority of their time to building their businesses — creating new products or services, building a team and developing new client relationships — often at the expense of ensuring that there is a viable way to monetize that value at some point in the future.
Unfortunately, this often leads to surprises down the line in the form of a delayed exit or a loss of value upon exiting the business, says Christopher F. Meshginpoosh, director, Audit & Accounting, at Kreischer Miller, Horsham, Pa.
Smart Business spoke with Meshginpoosh about the exit planning process and how to begin.
How soon should an entrepreneur start planning an exit strategy?
The reality is that it is never too soon to begin planning. Oftentimes, some of the early decisions, such as the form of the entity or the nature of the equity issued to the owners, end up having a significant impact on the timing or value of an exit.
Sitting down and spending some time early on thinking about long-term personal goals and exit options can help minimize problems down the road.
What are some of the exit options that an entrepreneur should consider?
There are a wide range of potential options that an entrepreneur can consider depending on his or her objectives. For example, there are strategies that an entrepreneur can use to transfer ownership to other owners, to nonowner employees, to family members or to outside investors.
What should an owner think about when contemplating a sale to another owner?
If this is a potential outcome for the business, owners should formalize their agreement about the mechanics and value of the transfer. If owners wait until an exit is imminent, it is often very difficult to get the parties to agree on these types of matters.
By entering into a buy-sell agreement that defines how the transfer will occur, owners can avoid many problems and distractions down the road.
What if the owner would like to keep the business in the family?
We see that quite a bit in our client base, and the good news is that there are several options available, including negotiating buy-sell agreements, transferring through gifts to other family members, establishing grantor retained annuity trusts, or establishing family limited partnerships. However, these options are all dependent upon identifying and grooming specific family members who can lead the business upon the departure of the existing owners.
Can you describe some of the strategies that can be used to transfer the business to existing employees?
First, there is one prerequisite: existing ownership members have to make sure that they have a plan to hire and develop managers who are capable of running the business. Assuming those managers are already in place, owners can provide senior management with equity incentives that reward management for increases in the value of the business.
This not only aligns management interests with those of ownership but also provides a way to gradually transfer ownership interest in the business. Once an owner is ready to transfer the remaining interest, it is often possible for management to obtain sufficient debt financing to purchase the owner’s remaining interest in the business. Other options include the formation of an employee stock ownership plan, or ESOP, to gradually or immediately redeem existing ownership interests and transfer those interests to employees.
What are the options if there are no other owners or employees capable of buying the business?
In those situations, either a partial or complete sale to a third party is necessary. Determining the right party is often a function of the owner’s goals, as well as of the willingness of market participants to purchase the business.
For example, if the owner is willing to continue to work in the business for a period of time, options such as a sale to a private equity firm or a roll up might be good alternatives. The sale of a partial interest to a private equity firm might also provide the owner with some upside potential if the business continues to increase in value.
If the owner plans to cease involvement at the time of a transaction, then other options such as the sale of the entire business to a strategic buyer might be the best alternative. Regardless of the strategy, owners really need to prepare for a transaction well before the planned exit.
In light of the time it takes to prepare, how do you recommend that an owner start the exit planning process?
There are many potential alternatives, and each one has its own unique complexities. Consulting with experienced advisers — including accounting, legal and wealth management professionals — is essential to avoiding obstacles and maximizing value upon an exit.
Christopher F. Meshginpoosh is a director in the Audit & Accounting group at Kreischer Miller, Horsham, Pa. Reach him at (215) 441-4600 or [email protected]
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