Why Business Owners Need a Succession or Exit Plan

For decades, vast wealth has been created for millions of Americans through growing private businesses. As Baby Boomer business owners reach the later stages of their careers, a 2016 U.S. Trust Wealth and Worth Survey shows that nearly two thirds have no formal succession plan or exit strategy. Since most business owners rely on their businesses for income, the lack of such planning means that their main source of income could be in  jeopardy.

Additionally, the study shows:

  • Only 16% plan to pass the business on to their families.
  • Sixty-three percent of older business owners (those over 50) have no formal succession plan.
  • Business owners don’t know how to get the highest value for their business.
  • They have no exit plan that considers their eventual retirement.

Many entrepreneurs never plan to stop working (not a good plan - what if the unthinkable happens?). Others may have a plan in mind, but most likely have not have even communicated it to key stakeholders. In my experience, not having a formal plan leaves a very low likelihood of an optimal transfer or sale of the business whether the plan entails a possible business sale to third parties or a succession to family members, business partners or other stakeholders. (For more, see: Succession Planning for Your Small Business.)

Benefits of a Succession Plan or Exit Strategy

The benefits of a thoughtful succession plan or exit strategy are vital to all stakeholders, whether they be the founder, the employees or the clients who have placed their trust with the firm. When they're ready to transition, the business owners are uniquely positioned to capitalize on the value of the firm they've built and help prepare for a smooth, strategic exit by the owner or for an unexpected change in circumstance, such as illness, disability or divorce.

For that reason, I believe that business owners need to think through five key considerations necessary to create a successful plan and exit strategy. Considering these elements will not only benefit you, but will also benefit all stakeholders of your company.

1. Make Sure Both You and Your Company Have a Clear Vision

If you want to get the most from your business, as Dr. Stephen Covey said, start with the end in mind. Picture what a success plan and exit strategy would look like and then work backwards. This will require soul searching and having a clear vision of where you want to go. Once you know that, you can set personal, profession and company-wide goals that will help you and the other stakeholders find the path to what you deem to be a successful outcome and exit strategy.

2. Truly Know the Value of Your Business

Most business owners either don’t know the value of their business or may over value the business. In order to plan for a strategic exit or succession, you must know the value and know how to increase the value to get to where you need to go in terms of your personal financial planning goals. Although there are many ways to determining a firm's value, operating cash flow (typically earnings before interest, taxes, depreciation and amortization (EBITDA) is the common denominator used to establish fair value. Buyers typically pay a multiple (that can be in the range of three to five times EBITDA or more) based on factors such as:

  • A stable and diverse client base.
  • Revenue growth.
  • Strong margins.
  • Continuity of key team members.

It's worth considering bringing in a valuation specialist or transaction intermediary to review the mix of goals, revenue streams, expense structure, legal structure, finances, clients and other available information. It may also be time to clean up the books. As the valuation is dependent on earnings, it is important to make sure that the books and records are in good shape. For that, I suggest a review and/or audit by your CPA firm. (For more, see: How to Create a Business Succession Plan.)

3. Maximizing Your Firm’s Value

Buyers will want to make sure that your business will continue after the sale. They will want to have assurances that key employees, customers, vendors and other stakeholders will remain in place after the sale. This risk can be mitigated with proper planning such as having:

  • Employment contracts or golden handcuffs for key employees.
  • Having a diversified customer and vendor base (or contracts).
  • Documented policies and procedures (and contingency plans).

4. Growing Your Firm or Maximizing Scale

Is your business the right size to attract the best buyers? You will want to show that you have achieved efficient growth without adding excess overhead while continuing to maintain good margins. Many times, I find that a company has a “strategic” size that it can be to attract the highest multiples and values from potential buyers. It is important to discuss this with a business broker or investment banker that can help look at your industry and guide you on possible strategic options to position your company to attract the best buyers, whether they be strategic buyers or financial buyers (such as private equity firms).

5. Demonstrating Consistent Growth in Revenues and Profits

When looking at a potential acquisition, buyers want to see that you have had consistent growth in your revenues while maintaining strong margins. This should be part of your three to five-year strategy before selling. Successful firms tend to have well-documented business development compensation and incentive plans in place for the entire staff, to ensure that everyone has a vested interest in the firm's growth.

Today's business owners have spent their careers building their company and relationships. Establishing a succession plan that secures their firm's legacy beyond the founder’s working life is critical not just to their firm and their clients but also to the long-term success of the next generation of leadership. The succession planning process can take as many as five to 10 years to establish and implement and there may be just one change to get it right to maximize the value for you, your family, your employees and all stakeholders. (For more from this author, see: Retirement Planning: What’s Your Hurdle Rate?)