Exit Strategy combines the business sale transaction with maximising the business price and ensuring the business owner can achieve their retirement. First, let's look at maximising the business price.
I spend a lot of time appraising the value of private businesses. Business value is essentially the future income stream discounted for risk (see my article on business valuation). Those two elements, Earnings and Risk, drive business value. If you can convince a buyer that future earnings will be the same or higher and that the risk of those earnings dissipating is low then you will achieve a higher price.
Earnings are easy to understand (usually last 12 months EBITDA) but what about the risks? These include large customers leaving, suppliers refusing supply, leases not being renewed, competition especially price and low barriers to entry, industry disruption from technology, poor IT and management systems, key people walking out and no CEO in place. Investors discount the price for these possible risks occurring in the hazy future.
Exit Planning includes taking a year or three to remove or mitigate the risks. The owner trains an internal candidate or hires an experienced CEO, systems are recorded in a manual, more customers reduce a large customer to less than 10% of revenue, a new lease is negotiated that extends for 10-15 years etc.
On top of this, the business may have some new opportunities that could lead to much higher profitability. If, in the owner's judgement, they will lead to immediate increases in earnings then they should be launched. The last 12 months of earnings is key, show growth in earnings and you're likely to get a higher price than stable earnings. However, if they will simply increase near term costs for long term gains then simply be ready to discuss the upside opportunities of the business with potential acquirers.
What's the first question I get from potential buyers that are large companies? Who will manage the business on the owner's retirement? Not what's the price.
Hopefully, you have a CEO in place. You come in to authorise payments once a month but the business is running successfully under the CEO's reigns with no day to day input from yourself. Not true? Then its time to implement a succession plan or be prepared to commit to 2-3 years working for the new owner to mitigate new CEO risk.
Related to that is offering management (and possibly employees) the chance to buy you out.
For most business owners, the sale of their business is expected to pay for their retirement.
Quite reasonably they wish to retire with a reasonable annual income, travel internationally, extend the batch, buy a boat, help their children, and perhaps bequeath wealth to their grandchildren. They expect to quickly sell the business and move onto the next stage of their life.
The assumptions are the business will sell at a certain price and that price will achieve retirement goals. I've covered price above, let's look at goals.
As an AFA, I use a six-step process to provide client advice:
- Scope of Service, exactly what advice needs to be provided and what advice can I offer?
- Fact-finding, what are the financial goals, how much risk are client's comfortable with, what are their current net assets and net income?
- Research and Analysis, what income is required to achieve financial goals at a certain level of risk, what investments help achieve that?
- Advice, what financial and investment recommendations do I make that achieve their goals?
- Implement, a plan to implement the advice
- Monitoring, a plan to review the investments, goals, risk profile and income
If a client and spouse wish to retire on a real net income of $150,000 pa for 30 years then they will need almost $3 million put in a Conservative fund. But they also want to travel for 20 years costing $50,000 then they will need almost $750,000 put in a Conservative fund. What happens if inflation increases or returns decrease, what if the kids need a loan of $400,000 for their first house...let's say all up they need a lump sum of $6 million now that, properly invested, will achieve their financial goals.
If I value your business at $5 million what are you going to do? You could increase business value as per above but more simply you could work for another year or two and save most of the earnings to get you to the $6 million lump sum. You might consider KiwiSaver, sure you're older but the tax benefits may allow you to take money out of the company at a lower tax rate...
Exit Planning is considering more than the business sale transaction. It looks at how to increase business value, how to avoid working post-sale, and how to achieve your financial goals.