In this article:
- When to start thinking about a business ownership transition/exit strategy
- What’s the best type of exit strategy?
- How can business structure affect your exit strategy
- How to make a change in business ownership
Transferring your business to a new owner, or even closing it outright, can be a lengthy process. This can take even longer if you are passing the business on to an employee or family member who needs to be groomed and trained to run the business before you leave.
There’s a lot to think about and it’s good to be prepared well before you intend to step down.
When should you start thinking about your business succession or exit strategy?
From the day you start a new business or become the majority shareholder of your company, you should have an idea of how you intend to implement your exit strategy. It doesn’t have to be all planned out from day one, but you should have some idea in mind of what you intend to do when you leave or sell your business.
Will you sell the business outright? Pass it on to a family member or employee? How will you leave the business for the next owner? Will there be a next owner?
You don’t need all of the specific details laid out from the beginning, and it’s okay if your plans change as you go along. But it’s important to prepare for your future and to have an idea of when you want to retire or leave the business so you can start planning this important transition.
You should start getting things in motion for your plan of exit well before you leave the business— we’re talking at least several years ahead of time. Most exit strategies take a long time from start to finish, especially if you need to train the next owner.
What is the best exit strategy for your business?
An exit strategy can, and should, be different for every business. This will depend on the type of business you run and its financial structure (we’ll talk about how your business structure can affect this process below).
Here are some of the most common business exit strategies:
Acquisition, commonly referred to as “merger and acquisition,” is when another business acquires your company. They generally absorb it into their own and continue to offer your products or services as a new addition to their business.
This can help the new owner broaden their offerings, stand out against their competitors, or even eliminate you as a competitor.
If you know this avenue is something you want to move toward from the beginning, then you can craft your business to be more appealing to potentially interested parties. Just be careful not to cater your business to the needs of one specific company, because they might not be interested in acquisition (or could change their mind) and you’ll have a lot more to lose than gain.
Initial public offering (IPO)
IPO is the process of offering the shares of your private corporation to the public. This allows you to raise capital from public investors who believe your company will be worth something to the public.
This isn’t always the best strategy for truly small businesses, but for those that grow into franchises or large corporations that the general public will have interest in. And in order to use this process as an exit strategy, you’ll need to sell your individual shares. This is more common among partnerships and large corporations with multiple owners/shareholders.
Keep in mind that this strategy can heavily impact how you run your business and should be something that you’ve thought about from the beginning. You may need to tailor large business decisions to what the analysts believe will do well if you want the opportunity to take this route.
Offering the business for sale to your employees is a great exit strategy if you want to see your business continue for a long time. Your employees are more familiar with the business and company culture and generally already have the relationships with your customers that they need to be successful in the future.
There are a couple of ways you can do this. You can allow an employee (or employees) to buy your company outright, or allow them to finance the company by paying you monthly or annual increments over time. If you go for the latter, be prepared to be involved with the business for a longer period of time during the transition. You’ll obviously want to ensure its success with the new owner so that you get your payment.
You may be interested in selling or legally transitioning the business to the next generation of your family or a younger sibling. Keeping it in the family can preserve the legacy of your business and the family name, but it isn’t without its challenges.
When considering this option, it’s best to look at the people who have been brought up with an intimate understanding of the business and how it operates. You want to sell or leave your business to a family member (or members) who are determined to succeed, particularly if you plan to benefit from any shares of the business during your retirement.
If you don’t have anyone interested in purchasing your business outright, then liquidation may be the best route. This is when you gather all your valuable business assets (like land, equipment, your building) and sell them.
Liquidation often occurs when businesses are facing bankruptcy or other financial hardships and need the money quickly. If you aren’t facing financial challenges, it may be worth holding out for a potential buyer.
How business structure can affect the sale of your business
The structure of your company can affect how you are able to pass on the business. So this is important to keep in mind as you build your business and plan your exit strategy.
Let’s talk about the basics of how your business structure can impact the transfer of ownership for your business:
If you are a sole proprietor or the sole owner of an LLC, then you can’t technically sell the business, but only its assets. This can include the branding, customer lists, equipment, etc.
This is because the ownership, in this case, cannot be transferred. The current business will be dissolved and the new owner will have to register it as a new business.
In a partnership, at least two owners share interest in the company. In order for one partner to leave, they will need to sell their interest in the company. This can be split among the remaining partners, or a new partner can be brought in if this is agreed upon by all the partners.
There may be more documentation required in this process, especially because most states have regulations on partnerships and you’ll have to register any change of ownership according to your state guidelines.
Limited liability company (LLC)
LLCs with multiple owners work similarly to partnerships when one of the owners is retiring or wants to sell their percentage of the company. The member buyout is generally laid out in the company’s operating agreement from the beginning. The remaining owners may buy out the leaving owner, in which case a new agreement would be written up and registered with the state.
Sole owners of an LLC, as we mentioned above, will need to value up assets and sell them, rather than transferring ownership.
C corporations generally have multiple shareholders that own stock in the business. Ownership is based on the number of shares that each owner holds. Because a C corporation is set up this way, the owner may have the opportunity to offer their stocks to the public through an IPO or to sell their shares to the remaining owners.
S corporations are similar to C corporation except for the fact that they are taxed differently and can only have up to 100 shareholders (where C corps can have an unlimited number). S corps often have bylaws that restrict who the shares can be sold to. Because of this, shares are often sold within the company rather than be opened up to the public or to another company.
Basics in the process of making a change of business ownership
There’s a lot to consider when it comes to making a change of ownership for your business. You have to gather up your assets, documentation, create a sales agreement, and set a date for all of this to be done by.
It can quickly become an overwhelming process. We recommend seeking the assistance of an experienced business attorney to guide you along your plan of succession.
There are a few main steps that you’ll need to take throughout the process. Be sure not to skip any of these. (This is where an attorney can be particularly helpful.)
Before discussing any important details of your business, how much specific assets are worth, customer details, etc., you’ll want to have a nondisclosure agreement in place that ensures your information is protected from being used by a potential buyer outside of purchasing your business.
Indication of interest
Once the buyer and you have done due diligence and valued the company (or its assets), the buyer then submits an “Indication of Interest” that gives a range of value for the purchase. If you like what you see, then you can provide the buyer with more detailed information of specific contracts, customer lists, and financial agreements that you have.
Letter of intent
When the buyer has this additional information and a fuller picture of your business, they may then provide a “Letter of Intent” in which they offer a specific value for the business. This often discusses the details of the purchase, similar to a sales agreement, however, this letter is non-binding.
After the negotiation process has ensued and everyone and their attorneys have done their due diligence and are satisfied with the terms of the sale, then a purchase agreement is written up and agreed upon by all parties to guide how the purchase will play out.
The negotiations and steps it takes to value up your assets can take several months before a purchase agreement ever comes into the picture. And if you aren’t the sole owner and have partners to work with, the process can take even longer because of additional documentation that is involved.
These steps are general guidelines and it may be different if your intent is to leave your business to your children or liquidate it outright. Be sure to consult a business advisor and/or a reputable attorney to help guide you through the process.
A key point is, whatever your plans for succession, you need to be thinking about them YEARS before it’s time to sell, liquidate, or pass on your business. Don’t wait.
From the start of your business to the time when you transfer it to a new owner, it’s important to help your business have every opportunity for success so that you can make the most out of it when you leave.
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