As a small business owner or investor, you have started a business for various reasons. These could range from your need to follow your dreams, seeking financial or career independence, to pursuing your hobby or passion in life, to making it in the big league of the business titans – the ones who adorn the covers of well known business magazines.
I am sure that at the height of your excitement to get the business up and running, the last thing on your mind is an exit strategy. In fact it could be argued that the whole notion of an exit, whilst just taking the “bull by the horn”, seem utterly counterproductive. Who in their right mind would be contemplating an exit, when they have hardly started?
Needless to say, there are many reasons why you should plan and know your exit before you even start. Before I dwell into the various exit strategies, It is important for you to know why an exit strategy is one of the most important factors that you will and should plan for, whilst you dabble in the business of starting a business.
Why planning for an exit is important at the start of the business
The first truth that you need to know is that most businesses will mature and stall in their growth. The ones who sustain, grow and thrive beyond the macro economic growth are the ones that make it into the big league. Therefore, it is imperative that you have a plan and a view, as to how you are going to get repaid for the risk, investment, sweat blood and tears that you have poured into the business.
There are also many other reasons beyond the need to get a windfall. The irony of life is that, it will deal for any one, the twists and turns when we least expect it. Some of life’s twists and turns are inevitable, but its timings are not predictable.
Most business relationships do not end on a positive note. Therefore, you as a small business owner or investor need a plan and a view as to why, when and how you will exit, when things are not smooch between your partners and you. You should plan for this to be an almost certainty, as most relationships evolve over a period of time. Your partners and you are influenced by a myriad of people and business factors, and people change over a period of time.
Other than the certainty of paying taxes (in most countries), death is a certainty that you should plan for. You need a concrete plan and view as to how dependent the business is on your existence, how your family will survive and how your remaining partners will be able to conduct the business.
What happens if you are disabled through an accident or due to ill health? Who is going to take care of your family, investments and you?
When and how do you want to depart from the business? What are your plans to ride into the sunset? How are you going to recoup your investment and tenure in the business that you have started and nurtured, for a period of time?
How would you exit your business, if and when a new investment or business opportunity comes your way?
How would you exit from your business if you find out that some of your key stakeholders like partners, customers and suppliers were deceitful or defaulting on dues to you?
What are your plans when your business growth stalls? Do you just wait and bid it to happen and exit gracefully, foregoing all your hard work, risk and money invested in your business? No one can be that stupid!
As you would have noted, there are many reasons beyond recouping ones investment as to why one would and should plan for an exit.
First things first
Now that you know as to why you need an exit strategy, you need to be aware of a few essentials that you must take care when starting your business and planning your exit from the business. Most small business entrepreneurs ignore these to their own detriment. They see these as mere expenses and a waste of time. When things go wrong or absurdly right, these set of actions are what is going to cover you.
- Have a rigorous, fool proof financial accounting methods, policies and procedures in place, from day one. Most entrepreneurs ignore this!
- Have a shareholders’ agreement that clearly spells out your rights as a founding partner.
- Create a tiered (preferred) class of shares that enable you to pay out higher dividends and share of profits and one will ensure that you have higher voting rights.
- Get power of attorney documents signed by all partners giving you the right to run your business (legally), without undue interference or limitations by other partners
- If you have a limited company with a board of directors, get blank board resolution documents signed by all board members.
- Get an appointment letter attested to and signed by all partners clearly stipulating your role as the “Chief Executive Officer” of the company, your salary and tenure.
To most readers, the suggestions above must seem absurd, preposterous and over cautious. Believe me, when an opportunity arises for an exit, or when something goes wrong with your business partnership, you would really appreciate that you went through the arduous task of getting the accounting and legal work done. When things go so well or bad, inevitably cracks will appear in any partnership. The legal protection that you have wrapped around you will pay off big time! Most small businesses are too myopic in their approach to see this. They seem to forget that most business relationships do not end on a happy note!
So what are the exit strategies?
Initial Public Offering (IPO).
IPOs are a rarity. You are better off trying your luck in the lottery. Of the millions of small businesses in the world, only about tens of thousands ever make it to an IPO. Unless you have the backing of well known and solid venture funds, that have a track record of getting small companies public, this is not a recommended option for most start ups or small businesses.
By the time you become a candidate for an IPO, you probably would have diluted your equity to a point of irrelevance, before the vulture funds have agreed to invest in you and your business.
The process of getting prepared for an IPO is expensive and cumbersome. It involves lawyers, auditors, investment bankers and consultants who are all out for their fair share of meat.
During an IPO process you are under the spot light and subject to various regulatory compliances and audits that you probably never knew existed. You start off the process by being the ultimate salesman, convincing investors during road shows with investment bankers that your business is worth much more than it is.
Although IPOs are glamorous and famous, they should not be your first option. Most entrepreneurs still have a hangover from the dot com bubble at the beginning of this century. Don’t let the IPO stories of the early part of the last decade fool you.
However, if you have a unique technology protected by patents and are funded by well know venture funds, God bless you. You are truly one of the few who have the potential to win the lottery aka IPO!
Getting another entity to acquire your business is one of the most common ways to exit from a business. The principle is simple – find another business that is ready, willing and able to buy your business. Sell it and keep the money and occasionally get paid more for remaining in the business and helping the new owners run the business that you have started.
Most successful small businesses are acquired by much larger public companies. What this means in essence is that you are in a better position than the buyers are. This is so because the folks negotiating and making the acquisition decisions are not vested on their own money. They are gambling with Other People’s Money (OPM). Therefore, you have the upper hand in negotiating price versus the folks from the buying side. You are negotiating a value for all your blood, sweat and tears that you probably have vested over a period of time! The folks at the buying side are often just employees with little to lose.
My recommendation for small businesses taking this path for their exit is to know in advance their potential acquirers. This way, they could craft and design their propositions in a manner complimentary to a potential acquiring company. The trick is not to limit the exit to one or two suitors. Have an array of suitors and evolve your propositions over a period of time. This way, you have the potential of ratcheting a bidding war among multiple suitors or at the least create a strategic value to a single acquirer who may pay you a load of chunk more than what anyone else is willing to pay you.
Selling to family, friends and or employees
If you are a true believer (in your business) and if you are emotionally connected to your business, then selling it to a friendly buyer might be the best option. A friendly buyer could include your family, friends and or employees.
Small businesses that take this path are not doing this for an outrageous monetary exit, but rather to ensure that the quality, integrity and continuity of the business are assured. Very often, entrepreneurs who take this path are not motivated by personal glory or money, but rather are seeking buyers who will preserve what is important to the founder. Very often, this is not a functional or rational exit but rather an emotional exit which too often leaves too much cash on the table.
Bleed to death
I personally know of a few businesses owners who bleed their company dry on a daily basis. These folks don’t run it dry and red but rather pay themselves a chunk of salary and bonus irrespective of their company’s performance.
I know some of them that give themselves five to ten times the dividends the other shareholders receive. Although these activities are illegal in public companies, they are perfectly legal in private companies.
In these “cash is king” companies, the owners do not reinvest in their business nor do they consider growing their business. Rather than reinvesting money in growing their business, these “cash is king” companies, keep investments minimal and withdraw huge wads of cash and live off the income of these businesses.
Keep in mind that in most businesses, cash that is taken out for personal use is no longer available to the business for reinvesting. If your business plan deems that you must invest to grow, then of course, this is not a viable option.
There are other ways that a “cash is king” exit could work. You could get your family to loan you a huge chunk of money and pay high interest for the loans. This way the cash is kept in the family, safe from the taxman, your creditors, and your preferred shareholders and anyone else that is after your hard earned money.
A final note on exit
No matter what your exit strategy is, it is important to note that the valuation of your company is primarily driven by 2 factors. The paramount of which is the cash flow derived from the revenue that you generate. The other most important factor is growth. Therefore time and pace your exit when your cash flow is maximized (therefore your revenue) and when growth is poised to peak.
In fact, when you think about it, this is a truism that is applicable in your professional career or business. Always exit on a high note. Look around you. Great business leaders’ remains great because they exited at the peak of their company’s growth!
As the famous Aesop fables teach us “Affairs are easier of entrance than of exit; and it is but common prudence to see our way out before we venture in”.
I would recommend that you read the following relevant articles in my blog:
- How much is my business worth?
- The Experience is the proposition?
- The 6Ps to guide your everyday business!