For the continued, successful operation of your business and to meet your financial goals after you leave the company, it’s essential to prepare for that inevitable date years and to modify the exit plan as necessary before your departure date arrives.
Why You Need an Exit Strategy
Exit planning isn’t just for retiring entrepreneurs. Make sure that you create and execute an exit strategy several years ahead of schedule to maximize the chances of achieving all of your goals.
Here are several significant reasons for entrepreneurs to implement an exit strategy.
- New start: When their businesses reach cruising speed, many business leaders leave their managerial positions to start new businesses.
- Disaster planning: The activity of a business can be strongly impacted by natural disasters, social unrest, or financial problems, including liquidation or a change of owner.
- Tax optimization: Plan your exit strategy several years in advance to seize all opportunities for tax optimization.
- Cash flow optimization: Similar to tax optimization, business owners can maximize their post-exit cash flow through careful, well-thought-out planning over time.
Why Business Owners Avoid Exit Planning
The following list is by no means exhaustive but is intended to give you an idea of the repercussions for not planning an exit using the proper means.
Lack of knowledge about exit planning. Most new entrepreneurs don’t even know about exit planning, and the consequences can be devastating. Life risks such as accidents or serious illnesses make comprehensive and sustainable succession planning necessary. Preparing for what happens when the man or woman at the top of the company is no longer available is normal for any company. This affects production and logistics and–and above all–the ability of the entire company to act.
No plans to retire. To stand on your own two feet and build your own company requires courage and self-confidence. These two traits are, of course, not enough for success. That includes expertise, an existing market, and luck–luck because some success factors cannot be influenced. There are many reasons why entrepreneurs put the issue of succession on the back burner or suppress it entirely. One is reluctant to retire: they are determined to hold on to their businesses for as long as possible. Nobody likes to contemplate when they lose control of what they have built with their ideas and hands. That is human and understandable. But it would be best if you gave your own company a chance for rescue should an unanticipated catastrophe hinder the company’s leader.
The assumption is that the business will be ready for a sale when they are ready. When it comes to succession planning for company owners, there is never a “too early.” If you rely on planning to plan and execute an exit when you feel the need to go, things can get worse for you. Statistics show that less than a third of family businesses survive into the second generation of family ownership. Only 12% make it to the third, the primary derivative being not enough effort expended on exit planning.
An (often unrealistic) optimism of the time available for their businesses to grow to the amount of cash flow and value that can support their post-exit lives. The assessment of the “right” company value depends mainly on how healthy the company is currently, what future value it represents, and what value it creates for the potential buyer, in their opinion. For this reason, the focus should be on a generally solid corporate structure. Too much focus on maximizing company value can lead to opportunities being missed. Being an optimist is great for you and can be good for your business, too, but unreal optimism can only come back to hurt you. This leads founders to attempt to inflate corporate valuation and miss out on a consolidating market. It is much better to let a competitive market determine the company’s value.
Underestimation of the amount of income needed for a comfortable retirement. Have you calculated how much money you need each month to make ends meet during retirement? Is it as much as you are currently earning? Or can you compromise? The underestimation of the amount you need in retirement will ultimately push your plan to exit your business successfully.
The following four things can help you not underestimate the amount of income you’ll need to sustain a comfortable retirement.
- Health care costs and medication: Health problems commonly increase with age, increasing the cost of medical treatments and drugs.
- Energy costs: Anyone who no longer spends most of every day at work has more time at home. This also means that your electricity and gas costs will increase.
- Moving and renting: Moving can mean both: saving money or increasing costs. Moving to an area where the cost of living is different will significantly impact your finances.
- New hobbies and travel: You finally have free time which allows you to do the things you’ve always wanted, like take up new hobbies or travel. Of course, exploring and maintaining new interests and leisure activities impact your finances.
Overestimation of the return on invested assets. In my day-to-day work as a consultant, I have often experienced those company owners who are willing to sell underestimate the value of their retirement. Entrepreneurs often focus on the importance of their accumulated years of work experience. This view is perfectly understandable, but the buyer has an entirely different view. They evaluate the company, not the entrepreneur’s experience, from a return point of view and ask what future financial benefit they will get from the investment and how long it will take to amortize the purchase price. This ultimately determines the sum business owners expect to have by retirement. To get a realistic purchase price, take the buyer’s point of view and consult market experts to evaluate the company.
Overestimation of the value of the business. To be very clear, determining company value is one of the most challenging parts of a succession plan. Every entrepreneur regards their company as the culmination of a life’s work and as the primary source of retirement funding. That explains why expectations of company value always run high, often too high. This is, by far, the most common reason for the failure of negotiations between an old owner and a prospective buyer: the amount of the purchase price.
This overestimation of the value creates a twofold risk for the company:
- It won’t be easy to find a successor who is willing and able to pay the high purchase price.
- The successor overestimates the company’s ability to service the debt. This would jeopardize the company’s very existence.
Overestimation of the net profits after the sale. A business must be put up for sale at the best market price to take place under the best possible conditions. However, most owners are unprepared for the actual amount they receive as net proceeds. Net proceeds are the amount the seller gets following the sale of an asset after all costs and expenses are deducted from the gross proceeds. This amount is also affected by capital gains taxes paid on the net proceeds of the sale of their business. Business owners have a number in their heads on the transaction value of their business. Still, after they pay advisory fees, taxes, and other deferred payments, they are surprised and disappointed by how little is left for them.
Failure to recognize that there’s an organized, owner-centric, proven process to help them reach financial security. To be straightforward, assessment of the company’s value is no small matter and must be carried out very carefully and in an understandable way for all involved. Therefore, consult an expert exit consultant or auditor, if possible. Your value does not have to be unorganized. The right consultants can help you determine which measures can be taken to increase the company’s value from the buyer’s perspective and show how a company is evaluated in theory and practice.
Lack of professional experts who can help owners on a specific exit path. Like all other processes in a company, and exit process must be thoughtfully prepared and carried out. While there are several ways to determine the value of a company, there is no one way that applies to all companies and industries. Experienced advice from third parties is essential to negotiate a fair price and a fair sale for a business. The lack of good advisors and consultants can often lead to you postponing or avoiding exit from your business.
Plan Your Exit Early
When setting up a business, owners plan everything down to the smallest detail, except, in most cases, their exit from that business. Avail yourself of expert consultants ready to help you plan and execute your eventual and inevitable departure from the business on the best possible terms for you and the company. To do this, it’s essential to prepare for your exit several years before the scheduled date and to revise and modify your exit plan, if necessary, at the right time.