For many entrepreneurs, building a successful business is the culmination of years of hard work, innovation, and risk-taking. However, at some point, almost all business owners reach a stage where they want to step away or back from the business, whether to retire, pursue other interests, or capitalize on their investment and years of hard work.

An “exit strategy” is a plan for how business owners can exit their business while also helping to maximize value, reduce tax liabilities, minimize headache, ensure smooth transitions, and help business owners recognize personal goals, such as the continued success of the company they helped build, or passing the business to desired family members, partners, or employees. In any event, drafting a well-thought-out exit plan is critical, as it allows business owners to move on when they want, and with confidence and peace of mind.

Although an exit strategy can take many forms, some of the more common exit strategies include:

1. Selling The Business To A Third Party

One of the most common exit strategies for business owners is to sell the business to an external, third party. This could include, among other things, selling to another business, a private equity firm, or an individual investor or group of investors. Selling a business to a third party typically involves negotiating the terms of the sale, including the price, payment structure, transition assistance, indemnifications, and any contingencies. The process may also include valuing the business, preparing financial statements and other due diligence documents, and negotiating with potential buyers. Most business sales take one of two forms: asset sales or equity sales. In an asset sale, the buyer purchases the company’s assets, such as equipment, intellectual property, inventory, and customer contracts, but generally does not assume, or take ownership of, the seller’s liabilities. Thus, following the sale, a new, separate entity owns and operates the business, using all of the assets of the original business. Conversely, in an equity sale, the buyer purchases the ownership rights of the seller in the existing business. Thus, the existing business, including all of its liabilities, continues to exist following the closing, just with new owners.

Selling to a third party may carry numerous benefits for a selling owner (and potential buyer), including:

• Maximized Profit: If the business has performed well, has a strong brand, or a dedicated consumer base, selling to an external party can generate a significant payout for a business owner.
• Offers A Clean Break: Selling to a third party can provide a business owner with a clean exit from the business, allowing the owner to fully disengage and move on to other ventures.
• Potential for Growth: From a buyer’s perspective, especially larger corporate buyers or investors, purchasing an existing business with a strong foundation may provide the purchaser with an opportunity to take the business to the next level using the buyer’s resources that the seller may not have had access to.

Although a third party sale, in the right circumstances, may offer a business owner with limitless opportunities, third party sales may also present challenges other exit plans might not. For example, some potential down sides of a third party sale include:

• Lengthy Process: The process of finding a buyer, negotiating the sale, and completing due diligence can take months or even years. Additionally, business sales also often require certain third party consents, such as landlords, lenders, or even vendors. If all parties are not onboard, closings can be significantly delayed or even impossible.
• Lack of Control: Many business owners are not fully ready to give up control of their company. Selling to a third party, especially through an asset sale, generally means giving up all control over the company an owner helped build.
• Post-Sale Involvement: Depending on the terms of the deal, the seller may be required to stay on for a transition period, which could be challenging if the owner wants a clean break.

2. Passing The Business To Partners

For partnerships or other businesses with multiple owners, one of the most common exit planning strategies is to employ the use of a "Buy-Sell Agreement" or other "Partnership Agreement" that calls for the ownership of the business to stay with the original or existing owners. Although such agreements can take many names, in general, a Buy-Sell Agreement provides each existing owner (or the company itself) with a right or obligation to purchase the ownership interests of any exiting owner, whether such exiting owner’s exit is due to retirement, death, disability, or other reason. The Buy-Sell Agreement will generally contain provisions governing, among other things, how such interest is valued, the process for electing or exercising the right or obligation to purchase, and the payment terms for the payout, helping to ensure that transitions are handled without conflict, and that remaining owners are not forced to govern with new third-party owners they did not originally intend to work with.  

3. Passing The Business To Family Members (Succession Planning)

For many business owners, passing the business on to a family member is the ultimate goal. Succession planning ensures that the business continues to operate after the owner exits, while preserving the family legacy. Succession planning typically involves selecting a successor or successors (often a family member) to take over the leadership and management of the business. The business owner may either give the business to the successor outright, or allow them to gradually take on more responsibility before fully transitioning ownership. As with other exit plans, succession plans can take many forms, and may involve bringing on successors as employees or co-owners, setting up trusts, or creating corporate mechanisms for transfer. Unlike other exit plans, however, succession plans may involve unique challenges, such as complicated family dynamics, successor lack of preparedness, and tax implications, including with respect to estate taxes. However, through prudent planning, including with the help of legal and tax advisors, succession plans can be as, if not more, successful as other exit plans.

4. Employee Buyout (ESOP)

An “Employee Stock Ownership Plan” (ESOP) or “employee buyout,” is an exit plan that allows the employees of a company to purchase ownership in the business and, if desired by the owner, ultimately take it over. This strategy can be particularly appealing if a business owner wants to reward their employees or ensure the business continues with those who understand its operations, principals, and customers.

In an ESOP, the business owner sells or grants all or part of their ownership stake to employees, either through a structured plan or a direct sale. This could be an outright purchase or a gradual process over time. Using an ESOP, or other employee buyout plan, can present numerous advantages, including:

• Preserving Company Culture: Employees who purchase the business are already familiar with its culture, values, and operations, which can help maintain continuity.
• Motivates Employees: Employees who become owners are often more motivated to ensure the business’s success, both in the short term and in the long.
• Tax  Benefits: ESOPs may offer tax advantages for both the seller and the employees involved. Sellers may benefit from deferred taxes, and employees may gain certain tax incentives through ownership plans.

However, ESOPs are not without challenges, including:

• Complexity: Structuring an ESOP can be legally and administratively complex, requiring proper financing, compliance, and valuation.
• Financial Challenges: Employees may not have the financial resources to purchase the business outright, which could necessitate outside financing, seller financing, or gradual vesting.

5. Liquidation

For some business owners, especially those who may not find a suitable buyer or successor, liquidation might be the most appropriate exit strategy. In liquidation, the business’ assets are sold off, and any remaining debts are paid before distributing proceeds to the owners. Liquidation can be a quick and straightforward process, especially for business owners who are unable to find a buyer or successor, or whose business is no longer viable. However, liquidation may result in financial losses, especially if the company’s debts exceed its assets, or if the liquidation process isn’t managed well. Additionally, liquidation doesn’t preserve the business, or its legacy, and is often seen as a less desirable option for business owners who wish to see their years of hard work continue in the form of a continued business.

Conclusion

Exiting from a business is a significant decision, and business owners have several strategies at their disposal. Whether selling to a third party, passing the business on to partners or family members, structuring an employee buyout, or opting for liquidation, each option comes with its own set of benefits, challenges, and tax implications. Ultimately, the best exit strategy for a business owner depends on the owner's personal goals, the business’s financial health, and the owner’s long-term vision. However, by planning ahead, working with legal and financial professionals, and considering the various options at an owner's disposal, business owners can help ensure a successful transition and a profitable exit when the time is right.

If You Or Your Business Need Assistance With An Exit Plan, Or Other Business Matter, Contact The Law Office Of Nicholas J. Vail, PLLC Today To Learn How The Firm May Be Able To Help.