Selling a Closely Held Business – Part 1: Exit Planning
Like boarding an airplane or going to the movies, take note of the nearest exit.
The owners of closely held and family businesses should consider exit planning during their regular business strategy review. Exit planning involves understanding the potential value of the business, identifying potential buyers, mitigating potential barriers to a transaction and managing the business to maximize its value to a buyer. Conveniently, there’s substantial overlap between good business stewardship and planning for an exit.
In closely held businesses, owners and managers are focused on operations and usually don’t have extensive experience buying and selling companies. However, advanced exit planning allows owners and management to quickly take advantage of strategic opportunities, such as industry consolidation, inexpensive credit or a "hot" market. Exit plans also allow owners to obtain value in the event unforeseen circumstances cause an involuntary exit.
Businesses that fail to exit plan will likely be among the estimated 70 percent to 80 percent of small businesses that are unable to sell, according to Mary Ellen Bairy, a financial journalist and researcher at Sageworks. Last year, the accounting firm PricewaterhouseCoopers found an increasing number of small business owners intend to sell rather than pass their business to family members. However, only a quarter of these businesses have any succession or exit plans.
Maximizing Value Requires Advance Planning
Planning to sell a closely held business might start with a valuation three to five years before the targeted exit date. A certified business appraiser might charge between $5,000 and $10,000, while a specialized boutique investment banking firm might charge between $20,000 and $30,000. The appraisal will provide a base valuation and highlight areas in which management should focus to increase enterprise value.
Owners should also begin identifying potential buyers. A "strategic" buyer might be interested in acquiring the company to enter a new market, grow a complementary business or vertically integrate. Alternatively, a closely held businesses might undergo a "leveraged recapitalization" in which a family member or a key employee obtains financing to buyout existing ownership. Understanding the universe of potential buyers allows existing management to develop relationships and operate the business to optimize its value for the anticipated buyer. If that buyer is a family member or an existing employee, advanced planning allows this individual to begin financial planning and skills training.
Begin Identifying a Team
Identifying a competent "deal team" requires prior planning because closely held businesses rarely have employees or engagements with professional service providers dedicated to buying and selling businesses. Internally, the company will designate an executive to lead the transaction. This individual should be intimately familiar with the company’s operations and finances and be able to command rapid responses from across the business. Also consider if the company’s ownership group is unified in its objectives for the exit or if various factions will need to be convinced through negotiations or exercising buy-sell rights.
A company’s existing accounting firm is in the best position to answer questions about prior years’ tax returns and financial statements. As part of long-term exit planning, determine if your client’s accounting firm has recent experience with transactions and ensure that the firm is prepared for a high volume of requests as the business is marketed. Also, consider if the accounting firm is preparing audited financials and whether the company should adopt any changes to accounting practices prior to a sale to provide a potential buyer and its lender a sufficient period of consistently prepared statements.
A legal team with substantial experience representing buyers and sellers of similarly sized businesses should also be identified. Dedicated transactional attorneys will have the benefit of negotiating a multitude of deals each year, allowing the attorney to rapidly and efficiently prepare and negotiate transaction documents. Unlike court cases in which publicly available judicial opinions disseminate the present state of the law, closely held businesses are acquired in private transactions subject to confidentiality provisions. Attorneys who are actively negotiating the acquisition and sale of similar business, however, will have current knowledge of what parties are agreeing to "market" terms. When identifying legal counsel, seek firms that have practice groups that are relevant to your industry, such as employment, environmental, international trade and intellectual property law.
Role of Estate Planning Attorney
Sellers should also consider their personal financial and legal needs. It’s advisable to begin estate planning prior to a planned transaction. The role of the estate planning or tax attorney is to assist clients to make an exit as tax efficient as possible. Beyond the pure legal issues, family-owned businesses have additional pitfalls. There’s an emotional component to owning a family business and an open discussion of exit planning and the family’s expectations might mitigate overly optimistic predictions.
Christopher Snider, president of the Exit Planning Institute, found that members of the baby boomer generation are owning businesses longer than previous generations, yet baby boomers are less likely to pass their companies to family members. This, combined with an absence of exit planning and frank conversations with family members, is expected to create significant strife as baby boomers eventually retire. If combined with advance exit planning, estate and tax attorneys may have tools to help clients avoid this strife by efficiently providing a financial benefit to family members after the sale.
Role of Investment Bankers
The business should begin forming relationships with investment bankers and business brokers with experience in relevant industries. Investment bankers should be able to provide guidance on how to value the business, identify potential suitors and, when the time comes, actively market the company to potential buyers. For industries with fewer transactions, working with a specialized investment banking group that has the capability to identify buyers in an otherwise stagnant industry might dramatically change the outcome of an exit. Even if the buyer is a known individual or entity, an investment banker may still provide value by identifying sources of external financing to avoid a seller-financed transaction.
Closely held businesses that undertake advanced exit planning will be ahead of 75 percent of their peers. Forming exit-oriented business relationships and institutionalizing sound business practices will contribute to making the client’s company marketable when the time comes to pursue a new challenge.
This article in the first in a two-part series. The second part will discuss the mechanics of a transaction and what a buyer will investigate when evaluating a business for purchase.