7 Main Types of Business Exit Options, Part 2: External Exits

February 24, 2021
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Last week, we talked about the first four most common types of business exit options. We featured the “internal exits.” This week, we will focus on the “external exits” that business owners can consider when it is time to sell their stake in a company and move onto the next chapter in life.

To recap, here are the 7 main types of business exit options:

Internal Exits (aka “Inside” Exits):

  1. Intergenerational Transfer
  2. Management Buyout (MBO)
  3. Sale to Existing Partners
  4. Sale to Employees (ESOP)

External Exits (aka “Outside” Exits):

  1. Sale to a Third Party
  2. Recapitalization (Recap)
  3. Orderly Liquidation

Internal exit options will have you selling your entire business or your shares in your company to your family or to other people already involved in running the business. On the other hand, external exits will have you selling to an outside entity or liquidating the company’s assets.

5. Sale to a Third Party

In this scenario, the business owner will sell his or her stake in the company (which can include the entire company if a sole owner) to a strategic buyer, financial buyer or private equity group. The sale can happen any number of ways, whether it’s through a structured negotiation, unsolicited offer or a controlled auction format.

On the positive side, an outside sale will usually bring the highest price in return. Buyers will pay fair market value (sometimes above market) if they feel your business is worth purchasing. The sale will bring more cash upfront compared to most internal transfers of ownership. You will be able to walk away faster and negotiate terms that are most suitable to you. You can avoid family squabbles and issues with business partners.

Unfortunately, third-party sales will typically require a longer process (9-12 months is pretty average). During that time, the owner (and any employees or managers) on the way out can become distracted and lose focus. This can potentially damage the business and hindering the sale in the process. An outside sale can spark new growth and energy in the company, but also cause fear among current employees who aren’t sure how it will affect their livelihoods. Of course, selling your business can be very emotional and that can make important financial decisions harder to make. Last but not least, third-party sales are usually the most complex and costly to close because so many contractual details have to be put in place.

6. Recapitalization (Recap)

In a recapitalization, the owner will sell minority or majority shares in the business to an outside lender or equity investor who will then act as a partner in the business. The goal of this is to re-inject some fresh capital in the business as you phase out your ownership role.

If you are looking for only a partial exit of the business, then this may be a good option to consider because you can sell a portion of your ownership stake. It allows you to diversify the business’s assets and reduce risks that come with other exit options, all the while bringing new capital investment into the business that can spark business growth. It is also a good second-chance opportunity if a business is struggling and you want to breathe some new life into it before moving on entirely. Another thing to consider is that this strategy can be implemented with other exit options as part of a multi-phase business exit plan.

With recapitalization, the accountability will continue to fall upon the existing partners and the new partner(s) who are investing. This will include you if you only sell a portion of your stake in the business. It can sometimes result in culture shifts and internal “shake ups” as the new capital investment often comes with new ideas and operational policies driven by the new ownership entity. Some of these deals can be relatively expensive compared to the actual benefit of the capital gains, so you want to be careful when pursuing recap as an exit option or as a business growth plan.

7. Orderly Liquidation

Sometimes the best option is to essentially pull the plug. Whether the business is slowly phased out of existence, sold off in pieces or closed quickly, you will liquidate the business and get what you can out of it. It doesn’t sound desirable, but often makes the most sense when asset values exceed the market value or the company is on a downward trend with no expectations of a recovery. It may be a sinking ship, so do you go down with it or toss out the life preservers and hope to save what you can?

In many business liquidation cases, the sum of the parts is greater than the whole. You can get more out of your business by selling off its valuable assets. It is a simple and efficient way to exit, and is generally going to be less expensive to do compared to other complicated exit options that require major contracts, succession plans and multiple phases to transfer ownership.

On the down side, there are no certainties with liquidation. There is no guarantee you will be able to sell off all your assets or what kind of money you will get in return for them. Of course, it can be an emotional process and can come with the stigma of failure, even if the financial result is better than it would be with a successful sale. You can have higher tax liabilities depending on how the assets are sold. Of course, the biggest downside is the effect it will have on your employees who will be out of a job.

As you can see, there are many different paths you can take as a business owner planning your eventual exit. Whether you decide to sell externally, transfer ownership internally or liquidate, you have many important decisions to make.

This is why it pays to have an experienced and objective business advisor in your corner who can help you explore all your business planning and business exit options as you prepare for your next business venture or an early retirement. Contact Illumination Wealth today to speak with one of our excellent financial planning consultants who can help you manage your personal wealth and business assets for a brighter future.