3 Phases of Building a Successful Business Exit Strategy

As a business owner, you spend much of your time planning how your company will grow and reinvesting most of your earnings back into the business to fuel this growth. But have you considered your exit strategy?

More specifically, how will you leave your business with enough money to fund your own retirement while ensuring the company you built can continue to thrive? Here's what you'll need to consider to put an exit plan in place.

The importance of an exit strategy

While reinvesting in their business, many owners will forgo implementing a qualified retirement plan and hold most of their wealth in the business's value. According to the Exit Planning Institute's exit planning guide, sometimes as much as 85% of an owner's net worth can be their company's value. The idea among these owners is that they'll liquidize some or all of their business's value when they're ready to retire, sell or pass business assets on to their heirs.

While this may sound like an exit strategy, it's actually just an aspiration. An exit plan requires lots of planning, and should start long before you exit your business—sometimes even before you opened the company's doors.

To plan for your own life after the business while ensuring it remains as successful as possible, consider the following phases. As with any type of planning, it's important to talk through these steps with a trusted financial professional.

Phase 1: Identify your post-exit needs

To identify your personal exit strategy needs, ask yourself these questions. Your third answer can help bridge the gap between the first two.

1. What do I need to retire or walk away from my business?
2. How much is my business currently worth?
3. How much more would I need to grow the business to meet my retirement income needs?

Work with a financial professional to complete a financial plan, set retirement goals and figure out how much you'll need to achieve them. Quantitative goals can help you determine existing household expenses and how much you'll need based on your projected life expectancy, while qualitative goals can help you narrow what you want from your company—and your life.

While this sounds simple enough, many business owners have some of their personal expenses—like auto expenses and insurance—intermingled with their business. This can leave them with a murkier understanding of how much money it takes to run their home.

Here are some questions to ask yourself to determine your qualitative goals.

• Is keeping the company name important to you, or are you okay with a name change if you sell the business to a third party?
• How long do you expect to stay in the business?
• Do you plan to stay on as a consultant until new management is more established?

Understanding the value of your business can help you determine if you'll be able to meet financial goals or if you'll need to grow its value. You can do this through a formal valuation—which can cost several thousand dollars—or you can build a projected exit plan using an informal valuation based on your company's financials.

You'll still need to determine whether the risks are low enough that transitioning the business will mean thriving in new hands—whether that's to a third party, internal management or the next generation. The way a business is sold—installment sale, consulting agreement, earnout or seller financing—often means that business continuity is a vital component to the seller getting the entire proceeds. Reduce any risks in the business before transitioning to help ensure that this continuity occurs.

Phase 2: Build business value and reduce risk

Every business is run differently, and each industry comes with even more nuanced ways to measure performance. Assess your company's practices to determine performance indicators or risks factors that might contribute to value building. Common categories that apply to most companies are listed below.

By working on one or more of these drivers to add value or lower risk, you're bridging the gap between your company's worth and what you need to exit. This gets you closer to the date when you can depart the company on your terms.

Phase 3: Choose the right exit plan for you

There are many ways to exit a business, but you can narrow your options by deciding to whom or what you'll transition your company. Typical recipients of a closely held business include:

• Employees or managers
• Charitable trusts
• Family members
• Co-owners or partners
• Third-party sales
• Third-party mergers

If you choose to transfer your business to employees or management, you'll likely consider strategies like managed buyouts, stock options, stock awards, equity plans and employee stock option plans, which allow you to defer capital-gains taxes.

If you transition to a co-owner or partner, you'll likely focus on buy-sell agreements and their structure. This includes cross-purchase, stock-redemption, wait-and-see and trusteed buy-sell agreements. You'll also determine provisions surrounding deadlocks.

As an example, let's say John and Mary O'Connell are a husband-and-wife team who've owned their business for most of their adult lives. They're nearing retirement and are getting ready to pass the company on to their two adult sons. They initially believe the company is worth about $4 million, but after focusing on a few low-performing value drivers and cleaning up some risks they learn that it's worth closer to $12 million. The potential size of the proceeds altered the exit plan they considered, leading them to change from gifting the business to their sons to selling it to a third party. This gave their sons $2 million each that they could use to start a new business or invest, while keeping the after-tax remainder for their own retirement.

The bottom line

When it comes to business exit planning, it's important to start early. Any or all of these phases can be emotionally intensive and require thorough analysis—not to mention more than one round of financial modeling and education.

Engaging in lowering risk and growing the value of your business is a good exercise even if you aren't considering exiting because it can help you run your company more efficiently. With better financials and performance, you'll be more likely to qualify for financing, attract and retain key talent and customers, and reduce volatility in your company's operations.

Having an established exit plan in place long before you think you'll need it can also help soften worst-case scenarios. Roughly half of all business exits result from one of the 5 Ds: death, disability, divorce, disagreement or distress. Having an existing plan in place can protect your business and keep your plan on track, no matter what comes your way.

To learn more about exit planning for your business, contact your First Citizens Wealth Management partner.