Exit strategies to consider when starting a business
An important, but often overlooked element of startup planning is deciding how you want it to end. In other words, knowing your exit strategy during the planning stage can greatly influence any number of decisions you need to make. The top five exit strategies, covering more than 80% of entrepreneurs, are:
Strategy n. # 1: sell to outside investors
Some entrepreneurs plan to establish a specialized business that can ultimately be sold to a larger company. Serial entrepreneurs tend to enjoy the startup phase and intend to sell their businesses to new owners once the business is afloat. Either way, it is critical to establish and operate the business with the goal of selling in mind. You need to understand how valuation works (how much a business is worth) and plan your financial and asset management accordingly. You need to make sure all trade protections are in place (trademarks, etc.) and do the work to build brand goodwill within your market and industry. About two-thirds of all startups consider selling to outside investors a likely exit strategy.
Strategy n. # 2: go public
Many startups, especially those in high-tech industries, hope to sell and get rich through an IPO (initial public offering). If going public is in your plans, you should hire a competent and experienced attorney to develop your incorporation documents and protect your interests. While you should understand everything in your entity’s registry and agreement, you should not do it yourself. IPOs can be very complicated and are one of the few things that entrepreneurs should hire an attorney to handle. Again, your assets and books will have to be in very good order, and your timing will have to be precise. About a quarter of all startups start with the intention of going public, but the actual number that have ever made an initial public offering is much lower. With the current state of the economy, it is likely to be more difficult than ever to get rich through an initial public offering.
Strategy n. # 3: sell to partners
Some startup partnerships are established with the intention of one partner buying from the others once the business is up and running. In any partnership situation, it is critical that all members define the hypothetical details and include them in writing in the Operating Agreement. For example, consider what will happen if one partner wants to sell their property: will the other partner have the first right to buy? How far in advance should a partner give? If they sell to a stranger, do the remaining partners have the right to approve the sale? How will the ownership interest be valued? If your exit strategy is to sell your stock to your partners, it is critical that you make a plan to do so before the deal is launched.
Strategy # 4 – Pass on to children
Although it is a less common exit strategy than in generations past, about 20% of entrepreneurs intend to build a family business that can be left for children to run. In these cases, it is important to set up your business from the beginning with the intention of long-term growth. Building a solid foundation is critical, both in terms of marketing and financial management. In addition, you should discuss the best way to establish business ownership with a competent and experienced attorney. Leaving a thriving family business behind can be a great legacy, but only if the business is built to last.
Strategy n. 5: transfer to employees
Another exit strategy that has gained popularity over the past decade is to use an ESOP (Employee Stock Ownership Plan) to sell the company to employees. Generally, these plans are established as trusts and the company makes tax-free contributions to the trust to purchase shares in the company. Employees are generally eligible to participate after one year of service, but do not accept distributions until they leave the company, at which point the ESOP repurchases their shares. Like any other strategy, ESOPs have advantages and disadvantages. Employees tend to be more productive and loyal, but having so many bosses can make decision making slower and more difficult. If you are interested in considering an ESOP as your exit strategy, you need to read up on the process and options and you will need a competent and experienced attorney to help you set it up correctly.
The bottom line
Determining your exit strategy is an important part of startup planning. Whether you plan to run the business yourself for the long term or build and sell as a serial entrepreneur, the way you plan and run the business should be influenced by that goal. Consider your options and look at the details now so you won’t have a problem when you’re ready to move on.