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Exiting a Small Business Part 1

  • October 22, 2019 4:16 PM
    Message # 8072162

    Owners who are exiting a small business are often stymied by the range of choices in exit planning. Most literature on the topic discusses seven or eight avenues to exit.

    A sale to a third party can be to an entrepreneur, private equity (including family offices,)  or a strategic acquirer. Internal sales can be to family, or to employees via  a Leveraged Buy-Out (LBO- often called a Management Buy-Out or MBO.) There is also a sale to an Employee Stock Ownership Plan (ESOP) or the oldest method in the book, closing down the company.

    While the jargon is appealing to those advisors who want to sound smart, most of it doesn’t apply to the 90% of owners who have fewer than 20 employees. For those owners, about half of those options aren’t realistic. Here’s why (or why not.)

    Exits That Don’t Apply to Small Business

    Strategic acquirers, as the term suggests, seek a strategic addition to their business. Very few small companies have exclusive rights to a product or territory. Even fewer have proprietary intellectual property (patents or software.) In fact, if you have less than 20 employees the odds are you do about the same thing as a number of competitors in your own geographic area. No strategic value there.

    Private Equity Groups and Family Offices have a fiduciary responsibility to their investor/owners. The level of due diligence needed to protect their interests makes a small transaction hard to support. They traditionally look for companies with more than $1,000,000 of cash flow after owner compensation, and many will only consider two or three times that amount. That’s too rarefied a level for most businesses with a dozen employees.

    ESOPs are a great transfer vehicle, but until they loosen the regulatory environment (some laws are being proposed) they usually cost several hundreds of thousands of dollars to complete, and another $50,000 or more for annual compliance thereafter. Too rich for most small businesses.

    When I say “small business,” I mean one with five or more employees. Smaller than that usually describes one person with some helpers. That’s more like a job, and closing is often the only avenue to exit.

    Exits That Do Apply to Small Business

    So, when exiting a small business with between five and twenty employees, you have three choices left. Sell to another individual, to your employees, or to your family. If you don’t have family in the business, your choices become even simpler. You can flip a coin, but even for small business owners exiting is usually a major financial event. It’s still worth putting some time and energy into planning.

    Reprinted from my exit planning blog at Awake at 2 o'clock?

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