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Formulating an exit strategy is part of growing a business. Just as a runner trains before a race to reach the finish line, entrepreneurs cannot afford to put off thinking about how they will get a return on their investment down the road when they want to move onto another venture.
Crafting an exit strategy should be a priority before a business progresses from the start-up stage.
“It’s got to be part of their operational plan from almost day one,” says Craig Bott, president and CEO of Grow Utah Ventures. “The reason for that is they have some strategic options in the growth of their company that will take them in one direction or another. And that direction is really dictated by how they want to exit and what market they are pursuing. Knowing early on how they want to exit will really drive their strategy from day one.”
An entrepreneur typically obtains a return on their investment through an initial public offering (IPO), a merger with a larger company or a purchase from an outside buyer. Considering an exit strategy early helps an entrepreneur decide which option is the best one for them.
Timing is Everything
Exiting a business too soon can cause it to fail. Waiting too long can diminish its value. Entrepreneurs must figure out how much time they need to grow a company to get the best value when it is purchased.
A delay in exit planning can cause an entrepreneur to lose leverage in obtaining favorable terms for his or her exit from the company. Business owners need to plan key details far in advance. If an entrepreneur intends to sell to a third-party buyer, for example, it is important to be able to fulfill due diligence requests from that buyer to inspect company books and records before making an offer.
If an owner has not planned ahead sufficiently before deciding to sell, it can result in receiving a lower offer price than anticipated. This can bog down the exit strategy because suddenly the entrepreneur doesn’t have enough capital to retire or move onto a new venture.
“Owners often feel compelled to continue working in the business and do not sell because they’re dependent on that cash flow from the business,” says Jon Parry, a Salt Lake City attorney certified in business exit planning. “Whatever amount of money they reap from the sale, that needs to sustain their retirement or their next business. If they can’t get enough out of that amount, then they’re probably just going to have to stay in the business, which can be very frustrating if they have reached the point where they’re ready to move on.”
Parry says tackling exit planning early can help an entrepreneur plan for whichever exit strategy they desire to implement. If they choose to eventually sell the company to a key employee or family member, for example, they can take steps to increase the value of the company and save them money over time.
Parry says exit planning with a business planning lawyer and CPA helps an owner get sound advice up front and avoid potential legal problems down the road. He notes that this course of action is especially desirable if more than one owner is involved in a start-up business. When multiple entrepreneurs are involved in a venture, things can get sticky when one owner leaves and others remain and no plan is in place to compensate the departing owner.
“Often there is going to be a dispute because we’re talking about money,” Parry says. “If there is no road map when one owner leaves, that’s just a ripe situation for dispute.”
Bott says 95 percent of exit strategies typically involve a purchase or a merger. Most purchasers are competitors within the same industry. When entrepreneurs decide they want to eventually exit via purchase or merger, it changes their mode of thinking. The goal shifts from beating a competitor at everything to showing them your company has value and would represent an acceptable acquisition risk.
Showing value can mean something as simple as offering evidence that the company is headed in the right direction.
“For a young startup, you don’t need to have demonstrated that you have captured the worldwide market to be attractive for purchase,” Bott says. “You can be very attractive to a buyer at an early stage.”
Advantages of Early Exit Planning
Early planners can take deferred compensation to save their company 20 to 30 percent in taxes while they receive the full value from the buyout.
They can implement stay bonuses to retain key employees after a merger or purchase so that a buyer does not have to worry about a flood of employees leaving to compete with them.
Entrepreneurs should secure trademarks, copyrights and trade secrets vital to the operation of the business.