The Cost of Not Having an Exit Plan
Do you have an exit plan for your business? Is your exit plan documented or something that’s just in your head as a future “to-do” activity? Do you periodically review your exit plan and measure your progress against the milestones? Every business owner should know these questions because only honest answers will help you determine the strategy towards your goal of a successful exit.
Having an exit plan does not mean that you must sell your business now. Instead, it means that your day-to-day management decisions support the end objective to exit and that you are focusing on tasks that matter for the success of your exit and future business continuity.
Building an exit plan is like planting a tree. Just like the Chinese proverb, “the best time to plant a tree was 20 years ago.” The next best time to plan for your future exit from the business is now. If you think you can wait until you need an exit plan or are on the verge of exiting your business, it’s already too late.
According to a survey conducted by the Exit Planning Institute, “only 20 to 30% of businesses that go to market sell; leaving up to 80% of those without solid options to harvest their wealth and ensure economic continuity into the next generation.”
This indicates that a business owner ready with an exit plan will have better chances of a smooth exit and a successful transition than one who is not prepared.
Why should you plan for an exit well in advance?
Selling a business is not easy. There are several considerations when planning your exit strategy. You have to prepare for your future and ensure the company continues. This can be an intimidating process, but advanced preparation smooths the transition. Achieving a successful exit usually requires four to five years of lead time, so planning early is critical to success.
Most successful entrepreneurs plan early.
To be successful in business means that do not believe in winging it. A formal plan lays out the course of action of your business for the next five years. It will help you see how you measure up against your own goals and whether you’re even on track. It will also keep your business thriving, especially during challenging and unpredictable times.
A savvy entrepreneur understands that successful planning increases the shareholders’ value. That entrepreneur sees exit planning as not just a process to look for a replacement in retirement or death but also as another way to preserve the company and culture with a win-win situation benefiting both the employees and the future business owner.
Building value over the long term drives your decisions.
Value creation is the outcome of building a thriving business. Building a future value proposition requires an actionable business strategy, a talent pool, and a growth mindset rather than a short-term focus on generating revenue.
When you focus on value creation from the beginning, many due diligence issues are easy to resolve since you already adhere to good governance practices or have the required documents.
Exit decisions are based on several long-term operational and financial goals, such as:
- Enhancing the strategic focus on value creation
- Optimizing the capital fabric of the company
- Tax planning efficiency, and
- Boosting the value of the company.
You need to know what that future exit looks like to plan for it.
Author Lewis Carroll’s enigmatic Cheshire Cat is famously quoted: “If you don’t know where you are going, any road will get you there.” In other words, you can’t reach your destination if you have no idea what it looks like in the first place. That applies to exit planning. You must plan for it to get there on your terms.
The Exit Planning Institute surveyed business owners from the San Diego area to find the hurdles owners face while selling the business. They focused on two key aspects: 1) selling the company at the time of preference and 2) selling the company at the price they desire. They received the following responses:
- Fifty-three percent of business owners said they had given little to no attention to their transition plan, even though three-fourths of the respondents were 51 or older.
- Eighty percent of business owners had never sought advice about an exit or business transition.
- Seventy percent of business owners were clueless about the after-tax income they needed to support their lifestyles.
- Only 58 percent of business owners had an estate plan. Among those with estate plans:
- 69 percent said their estate plans didn’t include an updated business value, and
- Sixty-five percent said their estate plans didn’t provide for the sale of the business.
- Two-thirds of these owners did want the total value of their business to fund their retirement and other interests. Yet, only 40 percent of them had a formal evaluation in the past three years, and shockingly, 65 percent had never even had their financial statements evaluated.
These statistics highlight the oversight of business owners when it comes to planning their exit. They have little or no awareness of the planning process, nor have they given any thought to their inevitable retirement plans.
The top goal of exit planning is to get the total value of the business to fund retirement. Still, in reality, many business owners will not be able to sell their businesses when the time arrives because they are simply not taking the most critical steps towards either exit planning or building enterprise value. When the time for exit comes, their attention will be divided between too many important details.
What are the risks of not having an exit plan?
Timely planning is essential for every successful exit. Planning strengthens the business’ value and the company’s market position and forecasts future potential. In contrast, a lack of planning will threaten the company’s future and its family’s financial security.
Every business needs a customized exit plan. This requires a detailed and thorough understanding of the business’s unique position, industry, market condition, business trends, business and personal goals, and exit timeline.
With so many interplaying factors, no one-size approach fits all businesses. Let’s take a look at a few outcomes of not having an exit plan.
Risk of Failure
Businesses need value-building actions to build their scalable value. When the focus is on value-building activities that prepare the industry for the exit, you also establish a profitable company with a growth trajectory, strategic importance, and recurring revenue stream.
When owners do not have a value-building plan, they have no control over the value of their business. Businesses that operate without an exit plan have a higher risk of failure. Companies must continually evaluate their value against ever-increasing competition concerning price, product quality, and customer loyalty.
Your business is growing, and the revenue is increasing. Although you have no intention to exit the company now, this is the best time to prepare your exit strategy.
When your business is doing well, and revenue is growing, you can further optimize your company’s business position in the market and use it to attract potential buyers. On the other hand, if the business is underperforming or things suddenly go downhill, an exit at such a time results in financial disadvantage or can be next to impossible.
Therefore, don’t consider the exit strategy as the end, but rather as planning for the future. The sooner you know what you are headed for, the more you can focus on your business and make it truly successful.
An exit, whether as an external sale or an internal continuation of the company, has better prospects of success if it occurs in a time of strength. If an exit occurs in a phase of weakness, a great deal of financial value is usually lost, and the firm’s likelihood of surviving the transition dwindles.
Unwilling Heirs to the Throne
According to a survey conducted in 2018 of 200 privately-held business owners, “58% do not have a succession plan, even though long-term transition planning has been shown to yield better business outcomes.”
You are fortunate if you have plans to transfer the business to the next generation. SupposeÂ your children are willing to continue the family business, ready to take over the company. You then have the time needed to plan your retirement and succession.
However, in many cases, children do not want to be part of their family business. Perhaps, they have moved out, built a life for themselves, and do not wish to uproot themselves to join the family business. Maybe they have different professional goals and interests. The reasons vary. What happens when the children do not wish to be a part of the family business?
Protecting your business’s financial value and health means you objectively look at the company, the industry, and the market to decide the next course of action. If your children are willing to take over the business, do not wait to plan the transition: start as early as possible. Likewise, if your children are unwilling, then it’s time to work through other options such as selling to an employee, partner, or investor.
Exit planning requires early preparation and consistent effort to grow and preserve the transferrable value of the business. When owners do not have a continuation or succession plan, they expose their businesses to a greater risk of falling apart.