We continue in our series on what it takes to design and implement a successful exit plan. We have discussed Setting Your Target Departure Date and Determining the Amount Needed from the Sale of the Business. We continue to explore exit planning with a discussion on step three in the process—Choosing Your Successor.
The Three Key Elements to a Successful Exit Plan:
As we discussed, most business owners define success as leaving the business:
- On the date they choose (Setting the Target Departure Date)
- For the cash they want or need (Determining the Amount Needed from the Sale of the Business)
- To the successor they choose (Choosing Your Successor)
To assist you in designing your exit plan, we work with five important pieces of information:
- Your target departure date
- A preliminary financial-needs analysis
- Your desired successor
- A preliminary valuation of your company
- A future cash-flow estimate
Element Three: Choosing Your Successor
Choosing your desired successor can be a daunting task. If you are like most business owners, it is a heavy burden, especially if you have not yet addressed the issue. Questions like “Who can I trust to run my business?”; “How do I know if I made the right choice?”; or “What if they run my business to the ground after all my hard work?” are all important questions that go beyond the bottom line of financial statements. After all, you’ve spent an untold number of hours and dollars, not to mention your blood, sweat, and tears in creating your business and making it successful. Because emotions play a large part in exit planning, these types of thoughts can be overwhelming. The good news is that effective exit planning can combat this worry and provide you with peace of mind for business’s future.
The number and type of possible successor owners is rather limited. Business owners must choose among, and usually have in mind a specific successor. Among the candidates are:
- One or more children or other family members
- A current partner or co-owner
- One or more key employees
- An unrelated third party
- An Employee Stock Ownership Plan (ESOP)
As you might imagine, there are advantages and disadvantages to each choice. Since there is no clear cut answer as to who would be the best choice, work with your advisor team to start the decision-making process. First, you should secure a preliminary valuation and five-year cash-flow estimate of your business. Second, establish your financial objectives both personally and as the business owner. Once you’ve assembled these pieces, your advisors will have enough information to show you the pros and cons of each possible exit path.
Some owners allow sentimentality to interfere with making the most prudent choice for a successor. For example, you may choose—for all the wrong reasons—a transfer to a child or an employee instead of a third-party sale. You must be aware of this possibility as a business owner.
Accordingly, an examination of your financial needs, combined with a valuation, usually provides the needed dose of reality. A third party will generally be able to pay more money but may not appreciate all of the “sweat equity” you’ve invested in the business. Similarly, while your family member or employee may appreciate the personal sacrifice running a business takes, he or she may not have the start-up capital or borrowing power to make the purchase happen.
These three elements are key to your successful exit plan. If you start preparing your exit plan today, you will control the process of exiting your business on your own terms.