The 8 Small Business Exit Strategies

Small Business Exit Strategies.  As part of the exit planning process, a business owner needs to make many decisions.  Selecting the best exit strategy is an important decision.  As a business owner, there are 8 options for exiting your business.  Below, we outline the 8 exit strategies, how each strategy works, and the pros and cons of each.  The 8 exit strategies are:

  • Sell to a third party

  • Sell to other owners or partners

  • Have key employees or management buy the business

  • Sell or transfer ownership to a family member

  • Sell to the employees using an ESOP

  • Refinance or recapitalize

  • Go public

  • Liquidate the business

Business Exit Strategies

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Exit Strategy 1: Sell to a Third Party

Selling to an individual unrelated to the business

For smaller businesses, a buyer will often be an individual (i.e. a person).  This buyer is typically looking to get out of a corporate job and become a small business owner.  They typically have enough money for a 20% down payment and have management experience.  Because it is likely their first business purchase, they will require more hand-holding.  They will ask more questions and take longer to make decisions.

Sell to a business in your industry

Selling to business in the industry is often referred to as a strategic purchase.  These similar businesses usually pay the highest price for a business.  This higher purchase price is justified through their existing systems and economies of scale.  Perhaps the buyer has the administration, service, or sales teams in place.  These systems reduce costs and make the purchased business more profitable and attractive.  An industry buyer could be a competitor, a supplier, a customer, or an ancillary business.  An example of an ancillary would be a restaurant buying a catering business.  While not in the exact same industry, there is synergy between the businesses.

Sell to a private equity group or investor group

Private equity groups and investor groups often buy businesses with EBITDA of $750,000 or greater.  Businesses of this size are often difficult for one person to purchase as they require substantial down payments.  Private equity groups may have a portfolio of businesses similar to yours.  By combining several companies, they are able to create economies of scale and drive overall value up substantially.  More often than not, a private equity group will have metrics a business needs to meet in order to close on the deal.  If your business ends up not meeting those metrics, they will withdraw their offer.

  • The seller is typically able to get the maximum sales price for the business.
  • Majority of the sale proceeds paid at time of closing.
  • An owner is most likely to receive fair market value for the business.
  • The seller doesn’t need to discount the price so a related party is able to purchase the business.
  • The large number of buyers allows the seller options so the exit planning objectives can be reached.
  • A seller may be forced out of the business sooner than planned or hoped.
  • The process of marketing a business for sale puts the business at risk of losing customers or employees.
  • This exit option will likely take 9 to 12 months
  • Not all businesses sell on the open market so contingency plans should be created.
  • Buyers may require substantial seller financing or earn-out arrangements.  This could expose owners without proper exit planning to additional risk.

Exit Strategy 2: Sell to Other Owners or Partners

Of the exit strategies, the simplest and most common is to sell to an existing partner(s).  This is the simplest exit strategy because each owner has a similar understanding of the business.  They will have an estimate of the business value and understand operations.  The other owners will also have existing relationships with employees, customers, suppliers and vendors.  This strategy bypasses many of the initial headaches associated with acquiring a new business.

exit strategy 2 sell to a partner
With this strategy, owners plan out and agree to the terms long before the sale.  Often, this strategy builds upon an existing buy-sell agreement.  A buy-sell agreement is an agreement the owners should put in place when starting a business.  The agreement outlines a plan for all of the potential planned and unplanned triggers for a business exit.  (In case you were curious, the triggers for a buy-sell agreement are: termination of employment, retirement, disability, death, divorce and bankruptcy.)

If there is not a buy-sell agreement in place, owners need to draft one as part of the pre-sale planning.  When there is an existing buy-sell agreement, the agreement needs to be reviewed and updated.  The main point of friction with this exit strategy comes when partners don’t agree on the value of the business.  Ideally, the buy-sell agreement includes a formula for determining the value and the parties can agree on the value.  Without a formula or owner agreement on value, a third-party business valuation or appraisal needs to be completed.

A sale to a partner(s) is typically a sale of stock or membership.  This requires the business maintain legal documents associated with the business.  Also, many of these sales are structured to include seller financing.  Often bank and SBA loans are available as funding sources as well.

  • The buy-sell often dictates a formula for valuation.
  • Sales process can be the simplest and provide for the smoothest transition.
  • The buyer knows the business.
  • Business stays in the ‘extended family’.
  • Buyer doesn’t need to be sold on why to buy the business.
  • Seller is able to deal with a buyer who wants to buy stock.  This typically reduces taxes for the seller.
  • Life insurance on the seller can facilitate an automatic sale and payment in the event of an unexpected death.
  • Banks are typically willing to finance a partner buy-out.
  • The sale to another owner typically doesn’t result in the maximum sales price.
  • If structured with a note, financial risk is created for the seller in the event of business failure after the sale.
  • Relationship between owners can go sour making the process very challenging.
  • If the buy-sell agreement valuation formula is incorrect, both parties need to agree to amend it.
  • Selling to other owners limits the buyer market and can decrease the company’s value.

Exit Strategy 3: Sell to Key Employees or Management

A management buy-out is the sale of business interest to the management team or key employees.  Depending on the size of the business, management and key employees may be synonymous.  With smaller businesses, a key employee could be the head of sales or engineering or the CFO.  With larger businesses, the entire management team are often key to the success of a business.  Like the other exit strategies, this option has its challenges.

The management buyout exit strategy is best for a business owner wanting to pass the business on to those who helped build it.  The sale can be for minority ownership, majority ownership or 100% ownership.  With this strategy, funding the purchase is typically the challenge.  It is rare for management to have the resources needed to purchase the business.  Because they lack the necessary resource, alternatives need to be evaluated. The first option is to get a loan from a credited lender.  Bank and SBA loans are typically available.  Another option is the leveraged buy-out.  In a leverage buyout, the management team loans against the assets of the business to finance the purchase.  If the buyers lack the assets for the remainder of the purchase, a seller can finance the remainder. In some cases, the management team can secure financing from a private equity firm.  This is rare though as private equity firms often require specific returns and have minimums they are willing to invest.  This is typically an option available only to mid-size businesses.
  • The business stays in the ‘extended family’.
  • Likelihood for business success is high as the management team knows the business.
  • The management team is able to share accurate forecasts and business plans to a lender.
  • Transition to the new owners is typically smooth as relationships and knowledge are maintained.
  • Allows the seller to maintain a portion of ownership and stay on as a consultant or board member.
  • For the management team, the seller is typically more willing to provide owner financing.
  • A seller may not receive the maximum price for the business.
  • The sale proceeds often have a mix of financing, cash and seller financing.
  • The deal may require investment from an outside party to make the deal happen.
  • If using a leveraged buyout, additional pressure is put on business profitability.
  • If the owner finances a portion of the sale, it creates added financial risk for the seller.

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Exit Strategy 4: Transferring Business Ownership to a Family Member

Transferring business ownership to a family member is a goal for 50% of business owners.  In reality, only about 30% of owners actually do so.  Transferring business ownership to a family member has many unforeseen and unintended consequences.  Because this option has a low success rate, you should plan on creating a contingency plan using one of the other exit strategies.

transfer the business to family

Transferring business ownership to a family member can be done a number of ways.  It can be sold outright, gifted, or a combination of both.  An estate planning attorney is a great resource to walk you through the tax implications and strategies available.  The biggest risk of transferring a business to a family member is if the business fails after transfer.  If a seller hasn’t been paid, it puts pressure on the seller’s financial and retirement plans.

Ideally, the seller works with a financial planner to determine what amount is required for their retirement plans.  A planner will calculate how much money can be put at risk with seller financing.  The planner can also model different payout options and how each impacts the retirement plan.  Family members rarely have the needed capital to purchase the business or provide a down payment.  These transfers often rely heavily on seller financing.

  • The business is able to stay in the family.
  • The family legacy can continue on for another generation.
  • It provides opportunity for future generations (i.e. grandchildren, nieces, nephews) to be involved in the business.
  • The seller can stay active in the business.
  • An owner can sell the business in chunks over time as child takes more responsibility.
  • Seller gets final say on the sales price and terms of the transfer.
  • Often puts additional financial risk on the seller in the event family member fails.
  • Unexpected consequence of family disagreements with other family members not involved in the business.
  • Treating all children or family members equally becomes very difficult.
  • If the family member fails, it diminishes inheritance of other family members.
  • If the family member fails, the seller may be forced to come back to work in the business.

Exit Strategy 5: Sell to all Employees Using an ESOP

An option similar to selling to management is to sell to all of the employees using an ESOP.  An ESOP is an Employee Stock Ownership Plan.  While an owner’s motivations are similar, the structure for the sale is very different.  To put it simply, using an ESOP is a complicated strategy that will only fit a select group of business owners.  It is the least common of all exit strategies.  To make it work, the business uses borrowed funds to purchase shares from the owner.  Those shares go into a trust which eventually vest or are purchased by employees.

The business stays in the ‘extended family’.

It is a tax efficient transaction for seller and employees.

An ESOP is an employee benefit.

Ownership in the company creates a new perspective for employees which leads to more revenue or profitability over time.

An owner can leave the business gradually over-time.

The owner can stay involved and slowly phase out of the business when ready.

  • ESOPs are complicated and expensive ($50,000 or more) to implement.
  • ESOPs require certain corporate and tax structures.
  • The company is required to offer a share buy-back when an employee quits or leave the company.
  • ESOPs are generally only suitable for a gradual exit over time.
  • ESOPs are subject to high levels of scrutiny by the IRS due to their favorable tax treatment.

Exit Strategy 6: Refinancing or Recapitalize

Recapitalization is where the owner alters the company’s capital.  Similar to other exit strategies, this strategy allows an owner to take money ‘off the table’.  This freed up money creates diversification of the owner’s balance sheet and lowers financial risk.  Typically selling to management or family are not desirable options for this owner.  In its simplest explanation, recapitalizing is bringing on a ‘business partner’. That partner can either be an investment group or a bank. 

If the new ‘business partner’ is an investment group, the investment group buys stock from the owner.  If the new ‘business partner’ is a bank, the owner takes on debt which is used by the company to buy the owner’s stock.  This exit strategy works well when an owner plans to stay involved in the business after the recapitalization.

  • The owner maintains ownership (equity interest) in the business.
  • Business owners are able to diversify their investment portfolio and mitigate some financial risk
  • Owner stays involved in the business management.
  • Provides the owner with liquidity in the event growth opportunities arise.
  • Seller can bring on a new partner with expertise to grow the business.
  • Increased debt puts pressure on business profitability.
  • The seller may not get along with new owner.
  • If majority ownership is sold, the owner loses control of the business.
  • Lender may require a personal guarantee from the owner.  This prevents owner from truly taking money of the table.

Exit Strategy 7: Go Public

go public

Possibly the most exciting of the exit strategies is to go public.  Owners often feel they’ve finally ‘made it’ when they go public.  When a business goes public, an initial public offering (IPO) occurs.  Through this IPO, shares become publicly-traded.  The IPO process starts by contacting an investment bank and making decisions on number or shares and share price.  An Investment bank purchases the shares and then sells the shares on the open market.

Going public increases prestige of a business.  It helps a business raise capital for growth and investment in equipment.  However, public ownership comes with many restrictions.  A public company has to meet strict reporting standards which can be expensive to maintain.  A private company does not have these reporting standards.
  • Going public provides capital so a company can grow.
  • An IPO can raise substantial amounts of capital.
  • Going public provides the business and its owners with liquidity.
  • A public company often has a higher profile.
  • An owner can offer more liquid shares to employees and thus attract top-talent.
  • Not an option unless your business is of a certain size or has a certain annual growth rate.
  • An IPO is very expensive in both time and money.
  • Business must have the correct business and tax structure.
  • Going public puts pressure on business growth.
  • Forces disclosure of business financials.
  • Business owner loses control of decision making.
  • Does not provide owners with immediate liquidity as most owners have restrictions on when and how they sell their stock.

Exit Strategy 8: Liquidate and Close Down the Business

With a few exceptions, liquidation is not typically the ideal exit strategy for a business owner.  An owner may not have any employees or family members interested in buying the business or other exit strategies available.  Whatever the reason, the business is hard to sell to an outside party.  Often liquidation is the last remaining option.

So, what is liquidation?  Liquidation is the process of selling off assets on the open market.  While often the simplest and fastest exit option, liquidating is not an easy process.  As an example, a business with specialized equipment will have limited buyers.  You can hire an auction or liquidation company, but it can be expensive.  Once the assets are sold, business debts need to be paid off before the business can be shut down.  Ideally the assets are sufficient to cover any debts.

  • The process is relatively fast and simple.
  • The owner can liquidate the business in phases.
  • Less profitable portions of the business can be sold off to make the business look more attractive to buyers later.
  • Liquidation can be the ideal strategy for a business with substantial hard assets but minimal income.
  • Provides cash to pay off debts.
  • Will typically provide the lowest possible value for the business.
  • Business liquidations are expensive with high commissions.
  • Employees lose their jobs.
  • The business legacy doesn’t continue on.

Conclusion: Take Time to Select the Exit Strategy that Aligns with Your Exit Plan Goals

Overall, planning ahead puts an owner in a position of control.  Knowing which option is best allows you to plan for the unexpected events that can occur.  A good exit planning team will help align your exit plan with the best exit strategy. 

By planning for your exit ahead of time, you reduce risk, minimize taxes, and more frequently achieve your goals.  Select the exit strategy that aligns with your exit plan.  This is one of the most important decisions you’ll make in the exit planning process.  If you have any questions, we’d love to help.  Send us a message and we will do our best to get back to you.