7 Main Types of Business Exit Options, Part 1: Internal Exits
On the Illumination Wealth Blog, our focus lately has been on exit planning for business owners. Last week, we put together a checklist to help you know if you are truly “ready” to move on. These next two weeks, we want to focus on the different business exit options that you can consider as you develop your actual exit plan.
There are 7 main types of business exit options that either fall into one of two categories:
Internal Exits (aka “Inside” Exits):
- Intergenerational Transfer
- Management Buyout (MBO)
- Sale to Existing Partners
- Sale to Employees (ESOP)
External Exits (aka “Outside” Exits):
- Sale to a Third Party
- Recapitalization (Recap)
- Orderly Liquidation
In today’s article, we are going to talk specifically about the internal exit options listed above. Stay tuned next week when we cover the external exit options.
What are the advantages and disadvantages of each option? What are the key things you need to incorporate into your exit plan? These are the questions we’re here to answer.
1. Intergenerational Transfer
We’ve found that approximately 50% of business owners would ideally like to exercise this exit option, but the reality is more like 30% who actually do. This exit plan involves transferring ownership in the business to your direct heirs. In most cases, it will be your children or other key family members you wish to take over your role in the company.
On the pro side, it’s a way to preserve your business legacy and “keep it in the family” for the next generation. It can be planned carefully and controlled strategically, and it generally won’t cost as much as other more complicated exit options. It usually leads to minimal business disruption, as well, depending on how involved the heirs are when it is time to make the transition.
On the con side, family dynamics can often be complicated. The sales price is generally lower than other types of business sales, and usually won’t result in significant liquid funds for the seller. It’s typically more of a hand-off than a cash-out. You also have to consider if it is the best long-term strategy for your business. Keeping it in the family seems like a great idea, but you have to weigh all the pros and cons and make sure the decision isn’t purely emotional.
2. Management Buyout (MBO)
In this scenario, the owner will sell all or part of their business to the company’s existing management team. The financing is done by utilizing the business’s assets to compensate the seller. An MBO can help ensure good continuity, especially if a succession plan is properly implemented. The buyers are typically motivated as they already have a vested interest in the company, and that will help make for a smoother transition while preserving existing human resources. In some cases, a management buyout can be combined with private equity to help pay off the seller and inject growth resources into the business.
MBOs are generally illiquid deals and this often leads to a lower sales price or heavy seller financing commitments. The other thing to consider is whether or not the managers taking over the business are actually good entrepreneurs. These leadership skills aren’t always one and the same. You want to make sure your company will be in good hands with the new owners, especially if you are retaining any stock or the payout is dependent on the ongoing profitability of the business.
3. Sale to Partners
If you are part of a business partnership, you can explore the option of selling your stake in the company to one or more of your partners. This can be a minimally disruptive transition approach that is well planned-out. The buyers are already owners in the business and this makes the sale simpler and cheaper as long as the buy/sell agreement is properly structured.
Again, you may not get top dollar for your stake in the company and there can be discord among the partners with you leaving, especially if only one of them is buying your stake and assuming more control of the business. Some of these sales are liquid with the partner(s) paying you the full price. Other partner sales can be more complex with the proceeds being paid out over time. You definitely want to make sure the agreement is solid to minimize your risk or any issues that could negatively impact the company after the ownership transfer is complete.
4. Sale to Employees (ESOP)
An employee stock ownership plan (ESOP) will essentially allow you to sell your business directly to your employees. It’s another way to keep the business “in the family,” whether or not any relatives are actually involved. You can share your purchase with pre-tax funds and any taxable gains on ESOP shares may be deferred. Some companies build ESOP shares directly into employee benefit packages when it is a known part of the owner’s exit plan. This can help inspire the employees because they are part owners, and you can set up a smooth succession plan thanks to their vested interest.
Unfortunately, selling to your employees can be a rather complex plan that is sometimes more expensive than other exit options. Employees come and go, and you should have a plan to buy back shares from departing employees. You will also be required to file a securities registration exemption. This option is good for a gradual exit, but has to be planned and implemented carefully to minimize complications and risks.
These are the four primary internal exit options to consider as a business owner. Next week, we will cover the three main external exit options.
If you are a business owner looking to plan your exit, manage your wealth and prepare for an early retirement, contact Illumination Wealth today for all your business planning and wealth management needs. Let us help you make the right decisions for your future.