Navigating Succession as a Small Business Owner
Every business will transition to new owners at some point. No matter where you are in the life cycle of your business, having a vision for your exit and how you plan to execute it is paramount to your lifelong success.
An owner who exits their business successfully remains in the driver’s seat throughout the entire process. Even though the nature of an exit is the transfer of power, they never lose control and are rewarded with many freedoms. Here are just some of the benefits you can look forward to when you properly plan for your own exit:
- Your business passes to the next owner or owners on your schedule.
- Your role in the transition is exactly what you want it to be from start to finish.
- You have the ability to realize the full value for everything you’ve created.
- If life changes along the way, your plan can be flexible while still getting you the outcomes you want.
Today, I will go over the five key areas you will want to consider when planning your exit strategy. We will explore your timeline, time commitment, primary objective, acquirer type and deal structure. I will invite you to get curious, think outside the box and start thinking ahead about what a successful business exit looks like for you.
KEY #1: YOUR TIMELINE
The three-year mark is your key transition point. If you are within this period, your focus needs to be on the negotiation and transaction to come. This involves cleaning up your financials, intellectual property and contracts. If you are more than three years out, you will have more time and flexibility for a strategic rebrand or hiring plan. In order of priority and based on your timeline, here are the most important steps to follow when mapping out your exit.
Clean up your books
First, consider your exit as your would approach listing your home. What repairs and deep cleaning projects are most necessary? If you were the buyer, what kinds of things would you be looking for? Start by taking a closer look at your financials in this way. A potential acquirer will want to see that your books are in good order and may require a formal review and restatement prior to the acquisition. Are your books and records clean and consistent? Are they compliant with Generally Accepted Accounting Principles (GAAP) accounting or a similar standard specific to your industry? Are your personal expenses still being run through your business?
Each of these things will need to be resolved during the transaction process, so getting ahead of these questions will help you in the long run. Failing to do so will ultimately cost you time and money and may potentially slow down or stop an acquisition.
Enforce your patents and trademarks
Once your financials are in order, you will want to think of other ways to secure and strengthen your market value. Have you developed any patents and trademarks within your business? If so, it is always a good practice to regularly search for any violations. If you discover a violation, most can be easily handled with a simple cease and desist letter. Continuing to enforce your hard-earned patents and trademarks will be a key factor in your overall value when you choose to exit.
Review your contracts
Next, you will want to evaluate the contracts that tie into the function and operation of your business. Consider the agreements you have with your employees, vendors and clients or customers. After an internal review, it is a good idea to have an external party look over them as well. This could be a mergers and acquisitions firm, business attorney or a peer within an entrepreneur’s organization such as True Space or Vistage. This will give you the opportunity to fix any inconsistencies or weaknesses prior to undergoing an exit.
Remove yourself from your brand
When you are outside of the three-year mark, you will want to consider how easy it would be to step away from a brand perspective. Unsurprisingly, many owners are the face of the business. While this is not inherently problematic, it can make a transition more difficult. Start by evaluating your company name, website and social media presence, and think of ways you could rebrand with a more neutral image, removing yourself as the main focal point. The ultimate goal is that every tangible within your business is elevated to exist beyond you. If you’re more than three years from an exit, you’ll have the time to strategize and transition your brand gradually and seamlessly.
Your team should be able to function without you
Depending on how much time you have before an exit, you may need to look at some additional hiring needs within your business. How easy is it for your business to operate without your presence day to day? What key management areas are lacking support? You will need at least three years, if not more, to properly recruit, onboard and train your team. This is especially true if you want to hire new talent to create a successor or group of successors that will purchase the business over time.
KEY #2: YOUR TIME COMMITMENT
Time is the most valuable and precious resource there is. That is why time is the second key to a successful exit strategy. You will want to consider how much time and energy you’re prepared to invest in the transaction before, during and after the deal is made.
Commit to the preparation process
Being prepared and thinking through every possibility well in advance of an exit will reap you the greatest rewards. Even if you are not thinking about exiting for another ten, twenty or even thirty years, it is never too early to strategize and begin on the steps mentioned above. How many hours are you willing to allocate towards building your vision and the preparation process? Give yourself the time and space to get clear and get organized. Pretend that you are going to exit sooner than you are expecting.
Decide how involved you want to be during and after exit
Think of the ideal schedule you would like to have during the exit process. In most cases, there is an expectation that you, as the seller, will work as an employee or consultant for a period of time to ensure a smooth transition. Begin asking yourself how involved you want to be in your business after your exit. The length and amount of time involved can vary widely from deal to deal, so be sure to have an idea of what you want before the exit begins. If you do not prioritize your own needs, the acquirer will prioritize their needs above your own. Having a clear vision of your guardrails will set the tone with the acquirer before the exit begins.
KEY #3: YOUR PRIMARY OBJECTIVE
The third key to exit-readiness is to define your ideal outcome and clarify where you are willing to bend and what you are unwilling to compromise on. You may be able to achieve a number of things that are important to you, your team and your clients or customers as part of the transaction but be clear about what is most important to YOU.
Consider the most common objectives
Begin by brainstorming all the possible outcomes from a potential transition out of your business. To help you get started, here are four of the most common objectives to consider for your exit strategy:
- Receiving maximum cash up front
- Realizing maximum total equity value
- Securing the best fit for your employees or team
- Securing the best fit for your clients or customers
What would most excite you?
Remember, there is no value judgment for how these objectives will rank for you. Make sure to consider your bottom line, but never lose sight of your highest ambitions. If you could wave a magic wand, what would your ideal outcome look like? I love how Tim Ferris puts it when he says, “The question you should be asking isn’t what do I want, or what are my goals, but what would excite me?” The beauty in thinking strategically about your business exit is that you can apply it to the bigger picture of your life. What kind of outcome or outcomes would you celebrate the most? What would most support your ability to live a remarkable life?
KEY #4: THE ACQUIRER
The fourth key in your exit strategy is to think about WHO you would ultimately like to sell your business to. There are two main types of acquirers—internal and external—and both come with their own sets of pros and cons.
If you have plenty of time, consider an internal succession
An internal succession might be a great option for you if you are outside of the three-year mark. Perhaps there is a family member or a person within your management team that would be a great fit. They are already invested in your business and know it well. If they are capital-limited, there are viable solutions such as Small Business Association (SBA) lending, industry specific banks and seller-carried financing that can help with the process. Another option is to recruit for internal successor. "Acqui-hiring" is the term used for hiring a competitor to become your future successor or leader. Although it may take several years to bring your internal team on board with an internal succession plan, this option will allow for the best control over your timeline as well as the best potential fit for your internal team and service to your clients or customers.
External successions are built for efficiency
If you are within three years and looking for the best total value or maximum cash up front, external successions are going to be your best bet. However, you will want to pay close attention to finding the most ideal fit for your team and clients or customers. When interviewing potential buyers, make sure to thoughtfully craft your diligent questions to uncover how good each potential fit would be.
KEY #5: THE DEAL STRUCTURE
The fifth and final key to examine for your business exit is the structure of the deal. Most exit deals are comprised of external capital, seller-carried financing and some other type of deferred revenue or earn-out. Your time will likely be part of the transition plan, so think about what your ideal structure would be and what your boundaries are around price, cash up front and your time. Having a vision for the deal structure makes it much easier to work through the ultimate negotiation.
Private equity deals are long-term but high in value
If you are on the larger end of the small business scale, one common scenario is to work with a private equity firm for a life cycle of around four to seven years. The firm would acquire at least 51% of the business at the start along with an agreement that the owner stays on board for some time. During this period, the owner works to meet certain growth targets, and at the end of the deal lifecycle, there is a final liquidity or transaction event. If the business has grown over this period, the owner may be able to obtain additional equity when the exit is finalized. This scenario provides two opportunities to retain a cash buyout for you as the owner, and it may present the most elegant solution in the transition of your business to new ownership.
Short-term deals with no post-closing assistance are possible
Long-term private equity deals are not for everyone, and there are plenty of deal structures that allow for quicker, cleaner exits. You may have the opportunity for a full sale to an investor with 100% cash up front with no post-closing assistance required from you as the seller. Other possible scenarios may include a three-year employment agreement after closing to aid in the transition to new management. The key here is to consider the right fit for your team and clients or customers.
SBA lending opens doors for businesses that have less revenue
If you are on the smaller end of a small business scale, the deal will likely carry quite a bit of seller-carried financing through the SBA. You may have a buyer who is bringing 20% cash down with 30% financing through an SBA lending option. In this scenario, you are retaining 50% seller-carried financing for a term of around seven years. If this works for you and your exit strategy, this can be a highly elegant solution for your team and clients or customers.
Thank you so much for checking out our blog. I hope you have enjoyed learning about the five key areas I believe to be of utmost importance when planning your own business exit strategy.
If you have a question or simply want to talk through your financial planning, we are here to help.
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DISCLOSURE: Jarrod Musick is an officer of Destiny Capital and Entrepreneur Aligned, a DBA of Destiny Capital. This article is for informational purposes only and should not be relied upon as a basis for your investment, business, or personal financial decisions. We recommend consulting with your wealth advisor, CPA/tax advisor and/or attorney, as applicable to your situation, prior to implementing any new tax, legal, or investment strategy. Advisory services provided by Destiny Capital Corporation, a Registered Investment Adviser.
ABOUT JARROD
Jarrod was born into financial planning and solving financial problems. With his financial advisor father Steve telling stories about finance around the dinner table from an early age, the idea that everyone has a different financial situation was always there. After an early professional career spent in nonprofit and government, Jarrod came back to his roots helping people plan and invest in 2011. Since then, he has worked with individual clients, led internal teams and ultimately became partner and the CEO of Destiny Capital in 2017. With a passion for helping entrepreneurs change the world, Jarrod ultimately oversaw the creation of Entrepreneur Aligned in 2020. With both Destiny Capital and Entrepreneur Aligned, Jarrod leads teams that help people live lives of abundance where money is simply a tool to let everyone be a positive force for the world around them. When he isn’t working with the talented teams for EA and DC you can find him chasing his twins, wily trout or a podium spot at an OCR race.
