Exits come in more shapes and sizes than most people realize.
While the permutations and variations between these are virtually endless, there are eight basic exit “archetypes” available to business owners as they look to the road ahead.
Each can be pursued as its own, standalone strategy, some can be used as a building block toward another, in a multi-step exit strategy.
Let’s take a look one by one.
1. The Bankruptcy
Let’s start with the exit no one wants, but which some have no real choice but to eventually select: the bankruptcy. Because yes, it is an exit – if an unfortunate one. It’s not the one you dreamt of as an aspiring entrepreneur, but having it as an option is one of the main reasons it’s usually advisable for entrepreneurs to do business in a limited liability corporation.
There are different forms of bankruptcy, some less final and definitive than others. For example, Chapter 11 bankruptcies often allow owners to reorganize their business with the idea of getting back on track in the future. This is because initiating insolvency proceedings allows you to negotiate new agreements with your creditors with the threat of bankruptcy looming.
It’s important to realize that bankruptcy is a heavily regulated process, and is subject to intricate federal and state laws. Also, even initiating this process could have serious consequences on many of your agreements, as some may have clauses stating they terminate immediately, while at other times your contracting party may have an option to terminate, once an insolvency event is initiated. Any bankruptcy must only ever be considered hand in hand with qualified counsel so you fully understand the ramifications and options available to you.
- Relief from some or all of your debts and liabilities
- The opportunity to start afresh
- You may not be able to discharge all of your debts
- It will impact your ability to borrow money in the future, such as to start another business
- You have to swallow your pride, and often be judged by others and lose some business relationships
It’s not uncommon for companies large and small to file for bankruptcy. Some do this as a way of permanently closing their doors, while others take this approach to reorganize their business to recover.
2. The Asset Sale
Asset sales typically aren’t a very attractive exit type. They’re usually most appropriate in situations where “the parts are greater than the whole” – i.e. when the assets or capabilities of the business have value, but are under-exploited because of underlying flaws in the business – usually some combination of insufficient capital, runaway expenses, or incompetent management.
Selling assets allows buyers to “pick and choose” what they want, often carefully leaving out liabilities and unattractive assets. This is what makes asset sales an appropriate exit option for an owner with a messy, often unprofitable business, but who has nonetheless acquired some useful assets along the way. Because liabilities are often left out in asset sales, they can often be combined with a liquidation or bankruptcy strategy by the selling owner.
When selling all or substantially all of the assets of a business, partnership clauses may require a special majority or a unanimous vote – so asset sales require a careful view of their consequences on the internal functioning of a partnership and the business as a whole.
- It’s a fast and efficient way to move on from your business
- It’s easier to execute than a sale of the business for an unprofitable business
- It accelerates the process of breaking free from your business
- You may be able to gain a profit from an unprofitable business
- Liquidation isn’t typically associated with a high return on investment
- You’re forced to part ways with employees, clients, and partners that you’ve come to know as a business owner
- They sometimes come attached with restrictions and ongoing liabilities, like warranties and representations
3. The Gradual Liquidation
Gradual liquidations can combine elements of bankruptcies and asset sales, but typically play out in a more controlled, step-by-step process over a longer stretch of time. Key assets can be sold gradually, while the business keeps operating. And a “Notice of Intention” under the relevant bankruptcy laws can trigger a restructuring process, whereby new agreements are made with creditors.
Naturally, there are consequences to gradual liquidations. The business can lose trust and goodwill in some of its relationships – and lose some of these altogether. Also, securing loans and bank financing will typically get harder, or come at higher interest rates and usually require personal guarantees.
While not as final as a bankruptcy or a sale of most or all of its assets, the gradual liquidation can be the appropriate exit type for businesses that are still operating, but for whom the weight of the past is simply too heavy to allow for real growth and flourishing.
- It allows you to remain part of your business longer
- It gives you time to possibly change your mind
- It keeps all or some of your workforce employed
- You’re sometimes dragging out the inevitable
- With ongoing costs, it often reduces the likelihood of taking in a significant profit
4. The Partnership Sale
For owners who have partners, one option to exit the business is, in a sense, built into it. They can sell all or part of their equity to their partners.
Many factors come into play when considering a partnership exit. Is the business profitable? How strong is the team? Would the buying partner have viable replacements for the strengths, relationships, and other inputs (capital, knowledge, etc.) of the departing partner? Answering yes to one or more of these questions may open up the possibility of a partnership sale and justify a higher price. Otherwise, arriving at a fair valuation for the shares of the departing partner could be challenging.
The partners can always refer to independent valuations to deal with the tricky issue of value. Even then, however, other tricky issues often complicate, delay, or break partner buy-outs: will the departing partner be subject to restrictive covenants? Will there be a balance of sale? If so, will it be secured? Will a bank or lender finance the sale?
This is why some partnerships provide for exit scenarios into their core partnership agreements. Forced buy-outs – where one partner has the option to buy the other out when certain triggers occur, under agreed-upon terms – are one option. Shotgun agreements – where a partner can make an offer for the other’s shares, and the receiving partner then has the option to either sell, or forcibly purchase the offering partner at the same price – can also be effective at resolving conflicts when a partnership is no longer tenable.
In all cases, partnership sales are delicate and very much case by case. They should be approached with care, with the help of qualified professionals. But like all other exits, some pro-active measures can facilitate and accelerate them.
- You can sell the business to someone who already knows the business
- You can make money on the sale
- If the personal relationship is still friendly, there’s a greater chance of staying on board in some capacity (if that’s your desire)
- It can sometimes be more difficult to sell to someone you know
- There may not be a manager or employee interested in buying when you’re ready to sell
- It has the potential to put off existing employees
5. The Internal Exit to Key Employees
Some owners primarily want some distance from the day-to-day grind of operations. This could be because they aren’t in love with their role and responsibilities anymore, or maybe they’d like to explore other professional opportunities. If the business has key employees who are willing and able to take on more responsibility, internally exiting to the benefit of these employees could be an appropriate exit type. If it doesn’t, a search for these kinds of employees – often combined with robust training and education initiatives, and a beefing up of internal processes – could be the appropriate next steps.
Internal exits to key employees come in two basic forms: selling them equity, or making them earn equity over time via an option plan. Selling equity comes with some advantages – cash to the founder or injected into the business, and financial skin in the game. The downside is this often creates more complex partnership issues. Option plans are a good way to make a conditional commitment and are associated with high retention rates. They come in many forms, from registered ESOPS, to custom-designed plans (sometimes involving shares, other times involving profit or capital interests), which allow an owner to play with vesting periods, strike conditions, and other terms and conditions. Warrants can also be used, in various scenarios.
Internal exits to key employees are often the best exit for small professional services businesses, and for owners still connected to the business but who need a break from operations. Another advantage of this exit form is that it isn’t “final” – founders can keep exiting and re-entering the business several times, each time to satisfy their life goals or give the business more of what it needs.
They can also be the first step in a multi-step exit strategy – setting up a sale to a third party in the future.
- You can transfer equity to people you trust
- You’re still in a position to make money in dividends or a sale down the line
- With a personal relationship, there’s a greater chance of staying on board in some capacity (if that’s what you want)
- It can be more difficult to sell to someone you know
- There may not be a manager or employee interested in buying when you’re ready to sell
- It has the potential to put off existing employees who do not own equity
Read this article for a full breakdown of how one business owner benefited from selling his company to employees.
6. The Open Market Sale
When you’ve created significant enterprise value and are ready to exit the business permanently, it’s a safe bet that the open market sale will the exit type best suited for you.
A business ripe for an attractive sale will have typically demonstrated superior returns, a competent team, and well-documented systems and processes. Showing growth or strategic alignment with the buyer can also lead to superior offers. Having legitimate strategic or disruption value in your industry can lead to offers far above what a standard valuation based on your numbers would justify.
When selling a business, process is key. Some founders find potential buyers within their existing network of relationships. However, when selling a business, it can be in the founder’s interest to generate as many bona fide third-party offers as possible. To make this happen, many will work with M&A professionals – brokers, lawyers or accounting firms with strong M&A practices. These professionals are best positioned to generate interest from potential buyers, juggle multiple offers, prepare founders for due diligence, and close the final transaction.
Selling your business in the open market generally includes the following:
- Determining what your business is worth
- Preparing your books and records for due diligence
- Marketing your business for sale, either on your own or with the help of professionals
- Fielding and comparing offers
- Negotiating, drafting and reviewing documentation
- Finalizing and closing the transaction
- You’re not limiting the number of potential buyers
- You may receive more than one offer, allowing you to secure the highest possible price or best terms
- Professionals can manage significant parts of the process on your behalf
- It can take time to find the right buyer
- The negotiation and due diligence processes can drag on for months or longer
- It’ll cost you a portion of your sale if you use a broker
As part of this process, buyer analysis is key. A business can be sold to competitors, financial buyers like private equity firms or VC’s, or industry consolidators. A well-articulated exit strategy builds realistic scenarios around likely buyers, and reverse engineers the process to present the opportunity as something that is interesting and realistic for the specific buyer(s) in question.
7. The IPO (Initial Public Offering)
As the name suggests, this exit strategy is all about selling your company to the public for a large infusion of cash from the capital markets.
As popular as it is in the business press and in the hopes and dreams of founders everywhere, in the world of business exits, it’s by far the least common.
Not only is it the most intricate and time-consuming of all exits from a process perspective, but the business must be truly suited for it, and its execution must be near flawless.
Owners who have completed IPO’s and whose companies were not growing quickly with the capital they raised sometimes feel they once had more control and fewer complications when the company was held privately.
Still, IPO’s can be the most attractive way to raise significant capital quickly for the right ventures – those showing rapid growth, stable and competent management, mature systems and processes, and the ability to complete the expensive and time-consuming disclosure obligations imposed by regulatory agencies.
- Worldwide brand recognition
- The opportunity to be the CEO of a publicly-traded company
- Earning larger payouts
- The most challenging exit strategy in terms of time, money, effort, and other resources
- Future involvement of analysts and stockholders
- Long-term success is very difficult
Every year, hundreds of companies go down this path. It’s rare, but it’s a dream the right business owners can aspire to.
8. The Succession Exit
Many people start a business with the idea of keeping it in the family and/or among a group of close associates over the long run. This ensures the prospect of long-term profits, and for the founder’s legacy to be kept intact. For that to happen, the right transition and estate planning mechanisms must be in place.
On the surface, this often appears to be the best exit strategy for the owners of mature and stable businesses — especially for small business owners who still own a majority stake in the business. Going down this path requires appropriate tax planning, often via wills and trusts, and preparing the business to be managed by the incoming group of managers. We often hear stories of the second or third generation “messing up” a legacy business – but far too often, the initial founders did not set up the incoming management for success. Proper succession planning aims at preventing this.
- You can personally select family members and/or key employees to take over your business
- You can groom your successors to manage the business when the time comes
- There’s a greater likelihood of remaining a part of the business, such as in an advisory or consultant role
- You may not have a family member who wants to take over the business
- It can cause a divide in your family, such as if you transition the business to one child and not another
- Your employees may not be happy with the person you choose to takeover
In addition to small businesses, many of the top corporations in the world are family-owned.
So, what’s the Best Exit Strategy?
By now it should be clear that the word best means something different to each business owner – in light of the nature of their business, their particular industry, and their values and life goals. It’s critical to properly consider all of these elements, and not to adopt a cookie-cutter approach to designing business exits.
Taking some of the factors discussed here, business owners can create a shortlist of exit strategies that might best suit them. It’s important to realize that an exit strategy can unfold in two, or even more steps, mixing and matching several of the business exit archetypes we’ve just outlined.
Once an attractive and realistic exit strategy is in place – which includes an understanding of the appropriate Exit Type, their Key Exit Player, and a realistic series of steps to go from where they are today to closing their ideal exit – business owners have a clearer picture of how they should design their businesses and make decisions. They also then need to shift their attention to preparing their business for the exit process, which is what our FIRE model is all about.