Have you ever considered why business owners decide to leave the businesses they built with immense passion, time, and effort? The company is probably the owner’s dream, so what compels them to give up on it?
Reasons to Exit the Business
The Business Is IPO-Ready
“An IPO is not the end, but actually the beginning.” – Madanmohan Rao
An owner may decide the best exit strategy is to sell shares of the company to the public to boost the company’s brand and raise more funds than might be expected from a straight sale. Such a launch into the stock market entails considerable expense and effort and should only be undertaken if the business has achieved a scale that justifies the cost.
Generally, the financial requirements of an IPO in the USA include the company having pre-tax earnings of $10 million in the last three years. A minimum of $2 million is earned in each of the previous two years. Stock exchanges impose other requirements based on the market cap, revenues, and several other metrics.
Uncertainty in the Market
“Even in times of economic uncertainty, good companies are still good companies — markets just don’t always treat them that way.” – Warren Buffet.
When uncertainty about future market developments or changes in government policies and business regulations adversely impact the business, an owner may seek to exit the business. Other times, the dominance of a significant competitor compels small business owners to exit. When such circumstances arise, owners need to plan and exit the business pre-emptively.
“If at first, you don’t succeed, try, try again—and then quit! No use being a fool about it.” W. C. Fields
If the business owner fails to stabilize the business and continues to lose money despite all efforts, then it’s time to call it quits. Quitting cuts losses from continued operation and stops the owner’s net worth from further erosion when a business venture has been unable despite putting in several years of hard work.
“Chase the vision, not the money; the money will end up following you.” – Tony Hsieh, Zappos CEO.
Novelty motivates entrepreneurs who love to explore new interests and wish to do something different each day. They often get bored when their business venture gets stable. Such a business has already crossed initial hurdles and proved its model in the industry. Further, all it needs is someone to address day-to-day operational issues.
Such a business owner will sell the business and move on in search of a new entrepreneurial challenge.
“Running a start-up is like chewing glass and staring into the abyss. After a while, you stop staring, but the glass chewing never ends.” – Elon Musk.
Situations such as continued financial uncertainty, changing business models, and failed deals with customers or investors lead to increased stress for entrepreneurs. Owners with innovative business ideas often feel lonely, as ordinary people seldom relate to them. Such circumstances take a long-term toll on their mental health.
Forty-nine percent (49%) of entrepreneurs have mental health problems. The study by the University of California clinical professor of psychiatry and an entrepreneur, Dr. Michael Freeman, says that depression (30%) is the most common factor, followed by anxiety (27%), which leads to mental health issues in entrepreneurs.
Some business owners choose to call it quits to save themselves from complete burnout.
“Often when you are at the end of something, you’re at the beginning of something else.” – Fred Rogers.
Reasons vary as to why a business owner’s current lifestyle conflicts with the demands of their business. These reasons may include advancing age, physical deterioration, financial goal achievement, marriage, starting a family, rediscovery of an old hobby, or the fascination of a new one. Whatever the reason behind the change of the business owner’s current lifestyle, it signifies when the owner wishes to exit.
Reasons for an Exit Strategy
Regardless of the business exit, the business owner must have an exit strategy.
An exit strategy is a method to liquidate the business owner’s stake in the business. An intelligent exit strategy helps entrepreneurs either limit losses or make profits, depending on the exit circumstances.
To achieve a successful exit, the business owner either needs the company to go public or another company to acquire. Most companies take the second route of merger and acquisition.
Most owners start considering their exit when they receive an acquisition offer, only to discover that their company is not “exit-ready.” Instead of facing a sudden decision that forces the owner to leave on undesirable terms, formulating the exit as an integral part of business development is a much better approach. By doing this, the owner is aware of the business value and knows what to expect. It also ensures the owner leaves the company in the hands of trusted people.
Many owners make the mistake of going to market without taking proactive measures to get their company ready. It often results in:
- A disappointing valuation, and
- A failed sale process.
A Disappointing Valuation
Making a business marketable and deriving good profit from the transaction requires that a company take time to get “exit-ready.” Before the prospective buyer assesses the company and finds flaws, the business owner needs to have a complete professional assessment of every aspect of his business.
If the owner has not proactively done a business valuation, he could be disappointed at the potential buyer’s value on his business. Being exit ready helps the owner have the upper hand in sale negotiations.
A Failed Sale Process
The process of selling a business is time-consuming and complicated. It requires careful planning and preparation. Common reasons why an owner fails to sell the business include poor operational or financial reporting, no streamlined business processes, management issues, etc.
Potential buyers don’t have the entrepreneur’s emotional attachment to the business or its personnel. They subject the business to an objective and critical review, looking much more profound than mere financials to seek the company’s proper functioning and growth prospects.
Many elements make a company exit ready:
Strong Financial Performance
Revenue speaks volumes about a company’s financial state. Prospective buyers expect that the company has a growing top line (i.e., payments). At a minimum, the company should earn stable revenue from a reliable and durable customer base.
As business margins significantly impact profitability, potential buyers prefer that the business margins be growing, or if not, at least be stable.
The business owner needs to inspect the state of business revenues and margins. A periodic business valuation helps owners spot the weaknesses in their business and affords time to take corrective measures.
Forecast and Budget
An indispensable component of business, forecasting helps management make informed business decisions. For example, production forecasting allows managers to decide what to produce and what resources to use. Financial forecasting applies past financial performance to current situations to predict the company’s future performance.
This vital tool creates an environment of stability and certainty, reduces financial risks, and helps assess the success of the company’s efforts to determine the long-term viability or value of an activity.
Budgeting is a powerful financial tool that helps small business owners maintain good financial plans, both short- and long-range. With it, business owners can control their cash flow instead of the cash flow controlling them.
Ideally, a company should have a financial budget, including a short-range, month-to-month plan for at least one year and a long-range, quarter-to-quarter plan for at least three to five years. Financial budgets should not only factor in income but also expenses. It is vital to take things like equipment purchase, real estate purchase, etc., for the business while budgeting.
Forecasting models also help with business valuations that use income-based methods for valuing a business. So, at the time of a business exit, companies with clear records of periodic forecasts and budgets showcase their business growth and the strategies that worked for their business. Small companies that don’t perform forecasting and budgeting receive no credit for the development of their business.
Potential buyers expect a company to have an active budgeting process and routinely perform forecasting.
Strong Financial Controls
Financial controls are the procedures, means, and policies a company applies to allocate, use, and direct its financial resources. They form the core of operational efficiency and resource management of the company. Potential buyers expect the company to have strong financial controls, including:
- The company should have financial statements reviewed by a CPA at a minimum and ideally audited.
- There should be no co-mingling of personal expenses in the business. Document all business loans appropriately with the correct mention of repayment terms.
- The company should have clean financial statements free of fraudulent or erroneous transactions.
- The company should perform accurate monitoring and planning of overall cash inflows and outflows.
- The company should implement effective financial resource management systems.
- Certified, qualified financial managers should handle bookkeeping, cash flows, payroll, etc.
- The company should have a periodic review policy, a stringent credit reporting policy, and a secured mechanism for saving financial data.
Owners of most small- and medium-sized businesses exit at some point in time due to any of the reasons discussed above or other unique situations. Regardless of the time and circumstances, the one thing that helps them get a successful exit is making their company exit ready.
Value Scout’s team of experts ensures that SMB owners understand enterprise value and work towards its growth to achieve a successful exit. We help companies focus on value creation by providing a professional analysis of current value, benchmarking baseline value to their future goals, and making them understand what will create value for them.