Business Succession – Timing Your Exit Strategy
At some point in time a business owner will want to exit their business and retire or possibly pursue other ventures. An October 2011 TD Waterhouse Business Succession Poll of 609 small business owners revealed that only 24% of small business owners surveyed had a succession plan for retirement. Most professional services businesses, including appraisal and real estate consulting firms, tend to be small businesses with less than 20 staff.
Owners who are exiting their business want to get the maximum value for their business and ensure continuity in operations to protect the interests of their clients. Small business owners have worked hard for many years to build and establish the reputation of the business name. In some ways growing and nurturing a small business is like guiding your child through growing up and maturing. Most owners want to see the business standards and reputation continue and grow under new ownership. This won’t happen automatically— you need time to plan your exit and transition from the business.
Common exit strategies for small business include:
- passing on the business to family members
- transferring the ownership interest to key employees
- selling the ownership interest to a remaining partner, or
- selling the business outright to a third party
The best exit strategy for a business owner will depend in part on the following:
- Owner’s target date or timeline for sale of the business
- The nature and value of the business assets to be sold
- Initial tax considerations in the disposal of the business interest
There are pros and cons associated with each option. The best course of action will depend on multiple factors including the ability and interest of family members in taking on the business, nature of partnership agreements (if they exit), strength of the business enterprise, and marketability of the business.
In some cases there will be no market existing for the business so the only course of action is to close and wind-up the enterprise. There are two main reasons for this scenario. The most common is that the business is a single professional service enterprise— the value of the cash flow is associated with one person, the owner. When the owner retires, clients may have little interest in remaining with an unknown party and few barriers may exist in transferring their requirements to competitors. Another factor may be the geographic location of the business. If a single owner-operator appraisal business is located in northern Ontario or other rural parts of Canada it may be difficult to attract someone to purchase the business even if the owner agrees to assist in transition of accounts.
An owner contemplating the eventual sale of the business must establish a timeframe for their exit. This target date, while not necessarily fixed, is important in order to trigger the other activities that are required to secure a suitable buyer and provide for orderly transition of ownership.
If an owner is planning the sale of their professional services business or an ownership interest they need to start getting the business ready for sale within three years of the planned exit date. The goal is to maximize the value of the business, fine tune efficiency to improve the attractiveness to potential buyers and in some cases, groom an internal successor. During this period an owner will need to avoid loans for major assets or business expansion to minimize growth in liabilities (debt). Owners should also be careful about staffing changes; adding or reducing the workforce before offering a business for sale. These decisions are best left to a new owner. At the same time, you can enhance the value of the business if you are successful in landing a larger retainer contract for ongoing services for a major client. A guiding principle is to be conservative in your approach to making significant business decisions when preparing a business for sale.
You will need time to plan your communications about the decision and timing on exiting the business. Your priorities will be family, partners, and possibly senior staff. If you intend to offer shares or the business assets for sale to staff you will need to consider how to structure the offering to avoid conflict within the firm and ensure you receive the best possible price for your business.
A two to three year timeframe is also required for tax planning purposes. Depending on the nature of the assets being sold the owner may face a considerable income tax liability. The tax consequences flow in part from the nature of the assets and business interest being sold.
In the next article we look at the nature of the assets that are associated with a professional services firm, such as an appraisal or real estate consulting enterprise, and options for selling the business:
- sale of shares in a corporation,
- assets in a corporation,
- a partnership interest, or
- a proprietorship.
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