Exit Strategies for Owners Who Want Out

According to Paul Simon, there are 50 ways to leave a lover. Not being as creative as Mr. Simon, we've only come up with eight ways for owners to leave their companies.

• Transfer the company to a family member;
• Sell the business to one or more key employees;
• Sell to employees using an Employee Stock Ownership Plan (ESOP);
• Sell to one or more co-owners;
• Sell to an outside third party;
• Engage in an Initial Public Offering;
• Retain ownership but become a passive owner; and
• Liquidate.

This article examines the advantages and disadvantages of each.

Transfer To Family Member

Owners who consider transferring their businesses to family members usually do so for non-financial reasons. Leaving the business in the hands of someone they know, trust and whom they believe will continue to run the company as it has been run for years is of paramount importance to these owners. The advantages to this route are:

• To transfer the company to a known entity — in particular, one's own flesh and blood;
• To provide for the well-being of the owner's family;
• To perpetuate the company's mission or culture; and
• To allow the owner to remain involved in the company.

The disadvantages to an owner of a family transfer are:

• Little or no cash from closing available for retirement;
• Increased (and continued) financial risk;
• Required owner involvement in company post-closing;
• Children's inability or unwillingness to assume the ownership role; and
• Family issues that surround treating all children fairly or equally.

In terms of advantages and disadvantages, the transfer to key employees is remarkably similar to the transfer to family members. Advantages include:

• To transfer the company to a known entity;
• To perpetuate the company's mission or culture;
• To allow the owner to remain involved in the company; and
• To achieve financial security.

The perils of this exit route are the same as those present in the family transfer:

• Little or no cash from closing available for retirement;
• Increased (and continued) financial risk;
• Required owner involvement in company post-closing; and
• Employees' inability or unwillingness to assume the ownership role.

ESOPs are qualified retirement plans, typically profit sharing plans, which must invest primarily in the stock of the sponsoring employer. The owner using an ESOP to effect this transfer usually does not want to remain with the company after closing. In addition to the advantages of a standard transfer to key employees, the owner who uses an ESOP to transfer a company to key employees enjoys three additional benefits:

• Cash. The owner leaves the closing table having converted an illiquid asset into the cash necessary for a financially secure retirement.
• Beneficial tax treatment. Using an ESOP, an owner can defer or avoid tax on the gain from a sale.
• Possibility of immediate retirement. Because an owner's financial security is not tied to the continued performance of the company, the owner can choose to leave the company.

Of course, not all aspects of this exit route benefit the owner. The disadvantages are:

• Cost and complexity of ESOP;
• Company growth curtailed due to borrowing;
• Less than full value received at closing;
• Owner assets (post-sale) used as collateral; and
• Key employee ownership is limited.

Once again, the owner who examines a sale to a co-owner(s) finds the list of advantages and disadvantages nearly identical to those found on the lists for a transfer to family member or key employees. The advantages to this type of sale are:

• Transferring the company to a buyer whose commitment, skills and knowledge are known quantities;
• Perpetuating the company's mission or culture;
• Allowing the owner to remain involved in the company.

The disadvantages of the sale to a co-owner(s) are:

• The need to take back an installment note for a substantial part of the purchase price;
• Increased (and continued) financial risk;
• Required owner involvement usually continues post-closing; and
• Less than full fair market value normally received.

This exit route offers an owner the best chance at receiving the maximum purchase price for his/her company. In addition, the owner who engages in a sale to a third party is best positioned to receive the maximum amount of cash at closing. Our list of advantages looks like this:

• Achieve maximum purchase price;
• Receive substantial cash at closing;
• Allow owner to control date of departure; and
• Facilitate company growth without owner investment or risk.

This is undoubtedly an impressive list of attributes. But before you grab the phone to call your favorite investment banker, let's review the drawbacks of this exit route:

• Loss of owner identity;
• Loss of corporate culture and mission;
• Potentially detrimental to employees; and
• Receipt of much of the purchase price subject to future performance of the company after it is sold.

The exit route marked "IPO" or Initial Public Offering is one that attracts the attention of business owners amenable to a sale to a third party for two reasons. First, the valuation of the ownership interest is usually higher than in any other form of transfer — including the sale to a third party. Second, an IPO brings with it an infusion of cash which moves the company forward to a new level.

Unfortunately, the IPO is not without significant disadvantages. The primary one is that despite the high valuation placed on and paid for an owner's interest, the IPO is not a liquidity event for the owner. The disadvantages of an IPO are:

• No liquidity at closing;
• No exit at closing;
• Loss of control; and
• Additional reporting and fiduciary requirements.

Another exit route that an owner can chose is to keep the business while assuming the role of a passive investor. This route attracts owners who wish to:

• Maintain control;
• Become gradually less active in the company;
• Preserve company culture and mission; and
• Maintain ongoing cash flow.

The disadvantages to this exit route are fairly obvious. The owner:

• Never permanently leaves the business;
• Is not able to establish or fix business continuity;
• Receives little or no cash when he leaves active employment; and
• Continues to experience risk associated with ownership.

There is only one situation in which this exit route is the appropriate choice: the owner wants to leave the company immediately and has no alternative exit strategies in place. Liquidation offers two benefits most important to the owner in that position: speed and cash.

Not surprisingly, the disadvantages to this exit route are enormous:

• Minimal proceeds;
• Significant tax consequences; and
• Effect on employees/customers.

Few owners pursue liquidation unless they have no alternative.

Which exit route is best for you? Which one meets your exit objectives? Comparing the advantages and disadvantages of each is a good way to start making that decision. Carefully compare the benefits and detriments of each path, viewed in light of your specific exit objectives as well as the value of your business. Armed with your road map you can take the most appropriate exit path for you, whether it is the autobahn to financial security or a winding and leisurely excursion off the beaten path. n

Editor's note: Provided by Lowenberg Wealth Management Group, Inc.