Exit, Stage Left
“Don’t cry because it’s over; smile because it happened.”
Dr. Seuss (attributed)
You’ve spent a lifetime building your business. Years of sacrifice, toil, sweat and tears. Eventually, every business owner faces a point in time when they must consider an exit strategy. This is particularly true for those who recognize the origins of this lesson’s title (hint, it was a cartoon character in the 1960s).
For some, this can be a very emotional exercise, especially if they hadn’t given it much thought over the years. In an ideal world, an exit strategy is part of a business plan. Yes, it seems a bit contrary and even defeatist to consider how you’re going to leave the business when you’re still working on opening it. But time is not on your side. The years will slip by, and before you know it, it’s time to move on in life, enjoy your golden years and leave the business world behind.
With proper planning, there’s every reason to think that it will end up in good hands, or if not, put some change in your pocket as you lock the door for the last time before handing over the keys.
Developing a Strategy
There are many strategies for exiting a small business, and not all of them mean closing the doors forever or selling it to your biggest competitor.
Each strategy has implications for you and your business, from intellectual property ownership and capital gains to serving as a consultant for a period of time in a staged transfer.
Even if you’re years away from facing this decision, you may want to read through this lesson so that you can give some thought to incorporating an exit strategy into your existing business plan. You just never know what the future holds.
When considering an exit strategy, here are some things to consider:
- The length of time you plan on being part of the business.
- The financial status of you and your business.
- Tax implications of various exit scenarios.
- Entities that may need to be compensated, such as investors and creditors.
There six common exit strategies for small businesses:
- Selling the Business to Someone You Know
- Selling on the Open Market
- Selling to Another Business
- Selling to Employees (ESOP)
There are times when an owner just wants to call it quits. Indeed, after all the events that transpired in 2020 and 2021, no one could blame any business owner for wanting to throw in the towel and move on.
Liquidation is the most visible form of exiting a business. A “Going Out of Business” sign and steep discounts are a clear indication that the business owner has called it quits. If the business doesn’t have any debts to be paid, no employees and no legal entanglements or outstanding orders, this method is known as a “walkaway.”
If the business has debts, then a liquidation can help offset some of these by selling inventory, land, vehicles, fixtures and other business assets. The business’ name may also be an asset if the company has brand recognition, a quality customer list, a strong customer base and intellectual property.
In a liquidation, any funds derived from the sale of assets must pay creditors first. The remaining funds can be disbursed among any shareholders, partners, or business owners. You may want to work with a liquidation professional to maximize the value of assets sold, ensure that employee discharges are handled correctly, and properly settle all legal and financial obligations.
- It’s easy. Everything just comes to an end.
- No negotiations are needed.
- No worries about transferring control.
- You may leave valuable assets on the table, such as customer lists and the value of any intellectual property, branding or community goodwill.
- If you have any shareholders, they may seek legal action to recoup their investments.
- Everything you’ve worked so hard to build simply goes away, as if it never existed.
Alternately, you can choose to liquidate your business over a period of time. This allows you to pay yourself until the business’ finances run dry. You simply stop putting money back into the business and pocket it instead. On the upside, you have the cash flow to maintain your lifestyle, but this method can also affect your tax situation.
Bankruptcy is the last resort for any business. Ending a relationship is never easy. It takes courage to admit that it is finally over. After all, everything you worked towards is crumbling before your eyes and the only thing left to do – for your own sanity and protection – is to leave it all behind.
It is a complex way to terminate your business since it requires you to legally file for relief and automatically triggers processes to protect creditors when your debts are greater than your assets. Bankruptcy requires that you hire a bankruptcy attorney who can guide you through the process and represent you in court proceedings. They will also counsel you on which form of bankruptcy best fits your situation.
A brief overview of bankruptcy options
Chapter 7 is a viable solution if your business has no future and needs to close. Often your debts far exceed your assets, and the only asset you have left is intangible: your skills and expertise. Chapter 7 is used primarily by corporations and LLCs because of the safeguards their structures have to protect and isolate personal assets from business assets.
When a corporation or LLC is closed, the corporate officer or managing member (in the case of an LLC) must liquidate the business’ assets and distribute the funds to creditors. The closure must be filed with the Secretary of State, and the officers must follow procedures closely to ensure that they don’t incur personal liability. Unlike Chapter 11 or 13, Chapter 7 does not have any mechanism for the business to continue operations. You must close the business.
If you’re a sole proprietor, you can also file Chapter 7. Just remember that you and your business are treated as a single entity, so you will be discharging all qualifying debt – personal and business-related. If you have more business debt than personal debt, you may not have to pass the Chapter 7 means test.
As part of the liquidation, a bankruptcy trustee will sell all of the corporate or LLC assets and distribute them to the creditors according to the priorities established by the state’s bankruptcy laws. Since all the assets are sold off, a creditor can’t collect from the company after it’s no longer in operation since nothing of value is left.
Chapter 11 allows you to reorganize your business with court oversight. The goal is to provide you with a plan to reorganize your business so you can pay off your creditors.
A business usually pursues this option because its value is greater than the sum of its assets. For example, the company’s name may have tremendous value in the marketplace, or the business owns trademarks and trade secrets that are not tangible but still have market value. This value would be lost if the company was sold or liquidated, so reorganization makes more sense.
There is a new subchapter of Chapter 11, which speeds up the process and lowers the cost. Known as Subchapter V, it aims to make small business proceedings more expeditious and less costly and includes provisions that may reduce a creditor’s leverage and require them to be more vigilant throughout the bankruptcy proceedings. It is ideal for small businesses that have less than $2.7 million in total debts.
When you file for Chapter 11, you become the “debtor in possession,” meaning you are still in control of your company’s assets and are responsible for managing them responsibly so you can bring the business back out of bankruptcy. A court may also appoint a bankruptcy trustee to monitor your activities and file reports with the courts or bankruptcy administrator.
Chapter 13 bankruptcies are typically a personal bankruptcy strategy. But if you are a sole proprietor, it offers you one additional way to reorganize, renegotiate or discharge your debts. That’s because a sole proprietorship isn’t a separate legal entity like an LLC or corporation. The assets and liabilities of the individual and the business are one. They are inseparable.
As such, all your property, holdings and income are available to pay all your debts, whether they are for you or your business. This means creditors have access to all aspects of your financial life so they can get paid.
Filing Chapter 13 does allow you to keep specific assets as they are considered tools of the trade or are exempted as personal assets. Protections are only up to a certain value and for specific assets. Every state is different on this, but here’s a link to Washington’s exemption statutes to help you understand what is included and what isn’t included in a Chapter 13 bankruptcy.
Selling the Business to Someone You Know
Rather than close a business outright, you can also use a sale as an exit strategy. Selling your business to a friend, customers, or relatives is one such option. To make sure the deal goes smoothly, you want to engage the services of an attorney to guide you before, during and after the sale to minimize risk and any unpleasant surprises.
- The buyer knows your business and you, so less due diligence is required.
- The buyer will preserve much of the business you built and has a similar vision.
- The transfer can be gradual, allowing you to continue to receive income while the buyer learns the business, making payments rather than cashing you out all at once.
- You may be less objective about the terms of the sale, let your guard down and leave money on the table.
- If you sell to a friend or relative, the relationship may be put at risk if some conditions or risks weren’t disclosed at the time of sale, such as back taxes or a pending lawsuit.
Selling on the Open Market
An existing business can be very attractive to a prospective business owner who doesn’t want to start from scratch, feeling they don’t have the experience to build a new enterprise from the ground up. A purchase of an existing business is far less risky and has the benefit of having existing systems, customers, sales streams and brand value already in place.
Before you consider liquidation or other more abrupt options, you may want to consider testing the market first. This takes some preparation, as you want your business to have as much perceived value as possible.
- If your business is in good financial shape, it will likely attract quality, qualified buyers.
- The business’ goodwill can be part of the company’s valuation since the buyer will derive value from the existing relationships and brand goodwill.
- You can offer to stay on in a consultant role for a period of time as part of the sale.
- It can be a long process to find the right buyer in the open market.
- Putting a valuation on your business can be complicated, and you may not get the sale price you were hoping for.
Selling to Another Business
It may be a difficult pill to swallow, but selling your business to a competitor can be a smart exit strategy. Your competitor may be happy to reduce the competition in the market, and often, you’ll have the chance to continue on in a role with the new company as a consultant. It’s highly recommended that you bring in an attorney to spell out all the terms and ensure that your interests are protected.
- Your competitor may be willing to pay a higher price for your company than you could get on the open market.
- The sale may create a culture and systems clash between the two businesses.
- Some or many of your employees may be laid off or reassigned to new roles they don’t like.
Selling to Employees (ESOP)
If your business is locally loved and has a lot of community goodwill, an Employee Stock Ownership Plan (ESOP) can be an excellent exit strategy. Your employees helped you build your business and will serve as trusted custodians of it going forward. They want the company to thrive and grow as much as you do.
ESOPs are typically created through a pension plan that 1) invests most of the employee’s pension money into the company and 2) workers may borrow against future corporate earnings to purchase additional stock. Money or stock the business contributes to take the plan is tax-deductible.
- ESOPs stabilize local economies because ownership stays in the community.
- The transfer of ownership allows the owner to cash out when they retire, knowing the company is in good hands and that all their hard work will go on.
- Employee-owned companies are less likely to lay off workers in economic downturns.
- Employees accumulate wealth through their shares. As such, they have a vested interest in the company’s profitability and growth.
- Set up can be complex and expensive, so you’ll need to bring in an ESOP specialist to navigate the transfer of ownership.
- Only corporations can form an ESOP.
If the business is small (fewer than 25 employees), profitable and debt-free, you may also consider a worker-owned cooperative where you sell the business to a group of interested employees through a traditional sale. Alternately, you could sell it to a single employee, such as a member of your management team.
Exit Strategy Case Study
A restaurant owner and his wife have been in business for 20 years. He works as the head cook and she, the manager. The restaurant is popular with locals and is turning a profit. They eventually decide to retire. They initially thought of selling the restaurant, but there wasn’t much to sell outside of the name. They were the business, right down to the recipes that drew customers in nightly. So they decide to close when they retire.
Ten years into running the business, the owner and his wife look at options for eventually leaving the restaurant business. To make the restaurant more attractive to buyers, they bring in another chef to learn the recipes and an assistant front-of-house manager to learn its ins and outs. Eventually, he adds a couple more assistants to learn the business. A decade later, the business is ready to sell. The business is far more valuable because there is continuity in the menu and operations. The buyer has a turnkey operation that already has a loyal customer base and an established reputation. The owner walks away with a tidy profit.