Starting a Business? Good.
What's Your Exit Strategy?

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BY THE SMALL BUSINESS AUTHORITY

When certified public accountant Jeff Sklar sits down to talk about a client's plans to start a business, he always asks how the client intends to get out of the business in future years. Even if the client foresees a long career before he ends his involvement, he needs to think about the end at the start, Sklar said. "Part of an opening strategy is an exit strategy," he said.

If you don't plan to sell your business someday, you can buy or create a business that will simply generate income for you and your partner(s). This is often called a "lifestyle business."

If you plan to sell your business someday, however, you will need to think about building equity. All your strategies would focus on growing your business to its utmost potential. That means making sure your business encapsulates something of value that would attract a buyer:
• Proprietary systems, patents, or a unique product
• Strong relationships with distributors
• A turnkey operation that runs efficiently without you or other key personnel
• A great track record in your market

Talking to an accountant like Sklar, who specializes in advising small businesses, before you make too many key decisions can help you think through what it means to want to sell the business as opposed to nurturing it and its employees.

"If the client is looking to grow it and sell it very quickly," Sklar said, "I would not recommend, 'Put in a pension plan,' because a pension plan costs money … [and] you want the net income as high as possible."

Sklar's No. 1 recommendation for small-business owners who are not looking to sell, but instead are hoping to generate income over many years, is this: Look hard at your projections. Are they realistic?

KEEPING IT IN THE FAMILY

Sklar, who is managing partner of SHC Consulting Group in Bellmore, N.Y., a company begun by his grandfather, said that if your exit strategy is to pass your company down to family members, you have some big decisions to make. Should you give it to your children or sell it to them, and what's the dollar value? An accountant can help you get valuations done.

If it's a corporation, you can sell stock to your children—maybe at a discount. If it's an LLC, you can own, say, 10 percent of the company and get 40 percent of the profits (losses), because ownership percentage and share of profits/losses do not have to mirror one another. That's all spelled out in the partnership agreement in a limited-liability company. You have many ways to maneuver when it comes to giving part of the company to the next generation. As a parent, you can retain the majority of the profits (losses) and still give your children equity.

Do you have an adult child whom you want to bring into the company but who is in a rocky marriage? Rather than give him a piece of the business, you might give him profit sharing.

Whether you decide to give or sell your business to the next generation, you need to consider taxes. If you sell it to the children, you could face a capital-gains tax. If you give it, you might pay a gift tax. (The tax law allows you to give up to $13,000 per year to as many people as you want, tax-free.) You'll need to know what your company is worth before you make a gift of stock or a percentage of the company. That's why you need the right accountant, one who understands how a small business works.

You may want to get out of your business at age 60 or 65, but do you have enough cash to live on after you sell or give the business to your children? Advance planning can lay the foundation, but you'll need to revisit your plans, tax law, and your company's value every so often.

PLANNING FOR THE UNTHINKABLE
Chances are your initial conversations about structuring your business did not address death or an irresolvable conflict with a partner. But those are both ways in which the business might end.

"With a partner, it's always tricky," Sklar said.
Perhaps there are four partners, and one of them wants to sell out and expects to get 25 percent of the sale price of $1 million. But his share is not really worth $250,000, Sklar points out, because he has a minority interest.

"In my world, it's worth far less," he said. "No one is going to buy his 25 percent interest on the free market. So we look at a business in totality and then based upon each owner's or stockholder's equity position."

You not only need to consider dissolving the business; you also need to look at the possibility of differences, disputes, or death. Here's one more sobering thought: If you don't plan for succession, you might end up with your partner's spouse as your partner. And we're pretty sure that's not what you had in mind when you went into business.

Here's a final word on exit strategy. A smart move you can make right now is to use a business-accounting model instead of a tax-accounting model—the way most small-business owners set up their books. Valuations are based on various formulas, but one of the most common is a multiple of EBITDA (earnings before interest, taxes, depreciation, and amortization). You won't know your EBITDA from your tax-accounting bookkeeping.