Regardless of the initial inspiration, as businesses mature and succeed, owners commonly share similar aspirations: to sustain their desired lifestyle, enjoy ample leisure time, and ultimately secure a comfortable retirement or transition to new ventures upon exiting their business.
Developing an Exit Strategy
Understanding the significance of preparing for a business exit is paramount for any entrepreneur. Establishing a well-defined exit strategy not only facilitates a seamless transition but also maximizes the value of your business.
One compelling reason for strategic exit planning is to maintain control over your departure terms. Without a plan in place, circumstances beyond your control, such as health issues or financial setbacks, could force an untimely exit. Proactive exit planning affords you the time needed to diligently ready your business for sale or transition, ensuring your departure aligns with your preferences.
Further, crafting a comprehensive exit strategy empowers you to optimize your business’s value. Through forward-thinking measures aimed at enhancing your business’s appeal, you can command the highest possible sale price or smoothly pass the torch to the next generation, thus safeguarding your financial future and reaping the rewards of your hard work.
We created an e-book that explains the steps in developing an exit strategy for the eventual sale of a small to mid-sized business. The basic steps of an exit strategy are outlined below.
If you would like a free copy of our e-book, “Navigating the Business Exit: A Business Owner’s Guide to Maximizing Value through Exit Planning” you can click on the link below.
Steps in Developing an Exit Strategy
Businesses values are primarily based on the company’s earnings. There are other factors, but in the end, the earnings drive value more than anything else.
When we say earnings, we are referring to Discretionary Earnings and EBITDA (Earnings Before Interest Taxes Depreciation & Amortization).
The most common valuation methodology is the multiple of earnings method. It is important to note that DE and EBITDA are different earnings values and both have different multiples.
The following blog explains how financial performance plays into valuation:
How to Value a Small-Mid-Size Business Using Earnings Multiples.
Business valuations use the last 3 years’ tax returns and the Year-to-Date P&L for the current year, and a projection for the current year-end. If there are significant differences in the tax return line items vs. the internal P&L it becomes very difficult to use the P&L for the Year-to-Date figures and year-end projection due to accuracy concerns.
Begin by examining your financial statements, comprising the balance sheet, income statement, and cash flow statement. Scrutinize these documents for any inconsistencies or inaccuracies requiring rectification.
The company’s financial statements not only establish the business value, but ultimately will determine whether the deal closes or not.
Businesses with excellent infrastructure typically sell quicker and for a higher multiple than those that are highly dependent on the owner. With good infrastructure and minimal owner dependency prospective buyers can envision an easier ownership transition and training period.
Businesses where the owner is a key employee, with few employees that can assist in the owner’s roles are much more difficult to sell, especially if the owner’s skills are highly specialized and technical.
Developing your staff be capable of handling most of the day-to-day operations is a key part of an exit strategy. Your objective is to make your self “replaceable”.
Many small and mid-size businesses operate without formal marketing programs, often depending on repeat clientele and word-of-mouth recommendations.
While you might not have felt the need for a structured marketing approach, especially if your business has consistently provided enough revenue to sustain your lifestyle, introducing a marketing program can significantly enhance your business’s appeal to potential buyers. Moreover, it opens avenues for new business opportunities and expansion, thereby enhancing the overall value of your enterprise.
Customer concentration may not directly impact business value, but it can make all the difference between a highly marketable enterprise and one that struggles to attract buyers or faces considerable value reductions.
When a significant portion of sales—more than 30%—hinges on a single customer, it raises concerns. If one customer contributes over 50% of sales, it poses a substantial risk, diminishing the business’s value and market appeal. While our firm has successfully sold businesses with customer concentrations as high as 70%, such scenarios are exceptionally challenging.
To mitigate these risks and enhance marketability, aim to diversify your customer base and reduce concentration to less than 20% to 25% for any individual customer. This can be achieved through strategic growth initiatives that expand your client roster and decrease reliance on a select few.
Tax planning is frequently neglected by business owners, with many assuming that taxes will inevitably consume over 40% of their proceeds from a sale. However, there are numerous tax strategies at their disposal to defer and minimize these taxes.
When crafting an exit strategy, it’s crucial to incorporate tax planning to accurately determine your net proceeds from the eventual sale. Your exit strategy should encompass both tax planning and financial planning, necessitating collaboration with your financial advisor to optimize your outcomes.
Establishing a current market value for a baseline is an essential part of your exit strategy. A current market value provides a baseline to measure progress against and set goals in your Exit Strategy.
Pacific Business Sales offers a free Market Value Analysis for our clients. We will work with you to develop a strategy for your business exit that captures your personal and professional goals.
