Exit plan a crucial aspect to small business ownership

By Gary Brooks

Business owners by nature are courageous folks who are comfortable taking risks. But there is one thing that seems to commonly invoke fear for them—the exit strategy.

The exit strategy is a critical element of financial security and yet, even many leading edge baby boomers with retirement in sight have no formal idea how they will get the most out of their business.

Business owners often let inertia stall their progress for one of four reasons:

1. the business defines their life and they can’t imagine a different situation,
2. they dread what may happen to the business without their guidance and the goodwill they’ve built with customers or clients,
3. they fear potential conflict in transitioning leadership of the business,
4. and/or they have anxiety about defining the value of the business and the financial realities it presents in funding the next stage in life.

Any of these concerns, left to linger, can limit the business owner’s options for an acceptable outcome.

THE SOLUTION

Business owners who are most successful with exit strategies have common attributes. They actively plan several years in advance. They perform due diligence with accountants, appraisers and industry experts to accurately value the business. They incorporate business value and transition timing into a personal financial plan. They understand all their exit strategy options, choose the preferred path, and align all decisions with maximizing the probability of success with the chosen strategy.

Whether the business has made a fortune or is just moderately profitable, the most successful transitions follow one of three planned exit strategies—the groomed successor, sale to an unrelated party, or the managed wind down.

THE GROOMED SUCCESSOR

Indentifying new shareholders among family, employees, or even friendly competition, can ease many fears. It allows the owner to preserve what is important to them and presents the least interruption to the business.

It’s not always simple to design an internal transition, but it may be the most satisfying option. The key is to start the grooming process early so that clear expectations and timelines can be defined, including how to structure the financial aspect of the transition. In some cases, successful businesses grow beyond an internal successor’s ability to afford to purchase it.

ACQUISITION BY AN UNRELATED PARTY

The first step in preparing to review offers for the business is to have a strong understanding of its value. When the right measure of value is determined, it’s important to manage the business toward improving that specific measure as much as possible.

The established value, and ultimately, the sale price, can have significant impact on taxes, retirement income, estate planning, and more inter-related elements of the owner’s financial situation. Sudden liquid wealth presents a whole different set of challenges.

THE MANAGED WIND DOWN

If the business is past its prime or in a dying industry, an option is to take as much earnings as possible out of the business as personal income rather than reinvesting in the company. This way, rather than expecting a future sale to generate a lump sum to retire on, the sum can be accumulated over time.

One risk is that this may be a tax-inefficient way to build financial security. Ordinary personal income tax rates would likely be more harmful than capital gains taxes that could be applied to a lump sum or installment plan sale.

A LESS-DESIRABLE OPTION

For too many business owners, it is a fourth option—closure and liquidation—that becomes the default choice. This often happens for reasons outside the owner’s control such as death, disability for themselves or a family member, or a change in demand (profits) due to the economy, industry evolution, and so on.

The best way to prevent settling for the default choice is to identify the facts, get good advice and use both to support a clearly emotional decision.

Gary Brooks is a certified financial planner and the president of Brooks, Hughes & Jones, a Registered Investment Adviser in Old Town Tacoma. Reach him at gary@bhjadvisors.com.