Do you have a Business Exit Strategy?

31 May 2020

Such as has been highlighted by the current COVID-19 pandemic, the domestic and global economy can be unpredictable, volatile, and filled with uncertainty. From sole traders to companies listed within stock markets such as the Australian Security Exchange (ASX), it is essential to have a strong exit strategy in place to, in a sense, groom your business for a possible future owner. 

In this article, we will discuss some of the key factors that are arguably essential to creating an efficient exit strategy that will ultimately help you keep yourself – and your business interests – better protected.

Planning & having the business less dependent on a key person

The more time you have set aside to plan for a potential exit for your business will influence the amount your business sells for in the future. You should allow at least three to five years to integrate an exit strategy for the maximum success – so that you can perfect and improve your business for disposal.

By allowing for this time to plan, it can help you to manage and navigate any natural events that could occur, which could be out of your control. Aim to have a sense of urgency when implementing plans, but remember to be detailed.

Regularly value your business

For some, this may seem quite straightforward. However, there are still many companies in this day who are experiencing a substantial loss of profits for not completing such a regular process. An example of this would be the British businessman, Robert Wright, who sold his venture Connectair for around £7 million ($12.7 million) in 1989.

Admittedly this seems like a reasonable price, however, Wright then went on to purchase the business back and eventually sold it in 1998 to British Airways for a sum of £75 million ($136.8 million). This anecdote helps clarify the importance of making sure your business is valued correctly and regularly to avoid irrational losses – regardless of where in the world your business is based.

Have a Business Structure that enables for a tax-effective exit

To allow your business to have a tax-effective exit, you first must consider its corporate structure. This should be completed when starting the business to allow for putting the most tax-effective business structure in place – with the possible exit strategy in mind.

If this isn’t taken into consideration, organising a restructure for your business to improve the levels of taxation could possibly take several years, which you may not have time for.

Keep business funds from personal funds

Ultimately, this factor will largely depend on your personal preferences and the overall size of your business. However, when it comes to planning a potential exit, from a legal and tax perspective, personal funds should be completely separate from the corporation.

This is primarily due to the business owner and the corporation operating on two separate legal entities When starting a business it’s not uncommon to face financial issues early on. In situations such as this, government grants are often available to help fund your startup. 

A broad list of some of the available startups available in Australia include:

  • Biomedical Translation Fund (BTF)
  • CSIRO Kick-Start
  • Entrepreneurs Programme
  • Export Market Development Grant (EMDG)
  • Research and Development Tax Incentives

If the business continues to use personal funds, it could end up causing both legal and tax issues. A good example of this would be the business being accused of generating dividends for the shareholders, which in turn falsely advertises the overall success of the business.

Have a potential successor in mind

Ample time should be provided for this preparation as the quality of the successor could be limited. Ideally, any potential successor should possess strong knowledge of the business and how it operates.

Common mistakes that are regularly made when choosing a successor include:

  • Choosing a less suitable candidate at late notice as the first choice is not willing to take control.
  • A candidate is receiving preferential treatment, such as a family member or close friend, and quality is not regarded (not for business reasons, but more for personal ones).
  • In a situation where the owner has many offspring, even though some may be unsuitable for the job, they all share the power that comes with it.
  • Gender is considered e.g. the best candidate is female, yet in this case, a  less qualified and skilled male is chosen instead.

By planning ahead, you will find it much easier to avoid many of the potential issues that may arise, such as the experience and age of the successor being insufficient. In this case, it is best to choose a longer time frame to plan and factor this into the equation. You should avoid being subjective when it comes to value and sentiment, and instead, focus more on the businesses needs.

However, it’s also important to remember that a bad candidate is better than no candidate all. But by having proper plans put in place, you should be able to maximise your chances of success with finding someone more suitable to take the reigns.

Consider key man insurance and buy-sell agreements

As a way of protection, business’s should apply formal agreements between shareholders, and/or partners. These will outline the circumstances in which they may consider to detach themselves from the business (e.g. selling shares/partnership equity, retiring, declaring bankruptcy or in some cases have passed away).

Key man insurance and buy-sell agreements are both components of a properly constituted business continuity agreement. These formal agreements can include information such as:

  • Financial concerns – Dividend policy and/or retirement policy.
  • Key man insurance – by having a restrain on trade provisions it avoids partners and other key staff from competing with the business once they have departed, this is also referred to as ‘restrictive covenants.

Many Businesses may overlook applying an agreement such as the previous, due to having personal relationships with the key shareholders, partners, or the business owner – thus helping to avoid the unpleasant aspects within a business such as retirement, disability or death.

However, without a strong agreement in place, it can depreciate the value of the business. This is typically due to problems that can occur during a sale such as:

  • Relationships can become hostile.
  • Unreasonable prices can be demanded for repayments of loans and assets owned.
  • Lawyers could be integrated into the process which can cost individuals a substantial amount of funds and prolong the process of the sale.

Formal agreements are essential for easing the process of the sale of a business as without them it can cause the sale to take a much-extended period of time costing all parties in the process.

Taking the next step to developing an exit strategy

If these factors are taken under consideration when implementing an exit strategy, you can expect above average results when disposing of your business while potentially maximising your exit price in the process.

However, there are many other factors which can affect the overall impact of a well-executed exit strategy,  each requiring significant time being spent researching, understanding and strategising an exit strategy specific to your industry.

If you are uncertain about the next step to take or are concerned with the effectiveness of your current exit strategy, Magnolia Advisory will be able to assist you. Our highly proficient experts understand the complex legalities and processes surrounding the development and execution of a business exit strategy, helping you have the peace of mind you need during such uncertain times.