Why Business Owners Need Exit Planning

Exit Planning Process. Whether it’s a sale to private equity or a family succession plan, our experience has been that it often takes years to successfully plan a business exit. Without proper exit planning, owners could pay more than necessary in capital gain and estate taxes, receive a less than optimal sale price, and/or fail to achieve their personal, financial, and business goals.

Business Exit Success Rates Are Astonishingly Low. With only 20 to 30 percent of businesses on the open market being sold favorably, it’s safe to say that success rates for business owners looking to sell are less than optimal. In addition to this, it’s estimated that roughly 50% of business exits are involuntary, with owners leaving due to unforeseen events such as illness or death. Yet, 41% of owners don’t have written contingency plans for such occurrences. Family business successions also fare poorly with only 40% making it to the second generation, and 13% surviving to the third.

Successfully Sold Businesses Can Still Have Issues Without Planning. Even for businesses that are successfully sold, there are still a myriad of pitfalls. 75% of business owners later regret selling their business. Some regret handing their legacy over to a buyer who makes significant changes to operations and the company’s strategic direction, while others regret how their former management team was treated in the transition. However, feeling a lack of purpose in their life after the sale is one of the most common issues we see.

Planning Can Mitigate Issues. Our view is that so many of these suboptimal outcomes can be mitigated through proper upfront planning. While 50% of business owners have thought through a plan, only 41% have a written plan. The remaining 9% have no plan at all. The process of going through a documented planning process can increase the probability of successful outcomes; however, there are numerous barriers to this process.

Barriers to Planning. Many business owners are overwhelmed with the day-to-day struggles and complexity of running a business in an increasingly competitive business landscape. While many admit that exit planning is important, it’s just not urgent for them. Additionally, many owners are aware that to properly prepare their business for sale, they’ll likely need to initiate structural improvements, implement systems and processes, and make investments. Change is hardly ever easy for most people, but diverting capital to investments that likely will increase enterprise value, while potentially decreasing the owner’s personal cash flow in the short term can be even more challenging. So often, inertia and procrastination derail the exit planning process before it even begins.

Exit Planning Increases Business Value. Even business owners who don’t plan on ever stepping away from their business should consider exit planning. Proper planning can increase the cash flow of the business, as well as its value. In turn, this could potentially help an owner reach personal goals such as legacy planning and charitable giving. Moreover, if the owner decides not to sell after going through the formal exit planning process, they’ll still likely have a more valuable business.

The Exit Planning Process. We recommend that owners begin at least three to five years ahead of when they think they will need to sell their business. This long time period will allow the owner and exit planning team to go through the three main phases of exit planning: the discovery phase, the preparation phase, and the decision/implementation phase. Since proper exit planning is both comprehensive and holistic, it can take a lengthy time to complete. Exit planning should address a full spectrum of relevant topics: business, personal, and tax issues, as well as the implementation of changes that will increase the value of the business. Our process was originally developed by the Exit Planning Institute through their Certified Exit Planning Advisor program and adapted through our experience implementing the process with business owners.

Assess Personal Readiness. The first step of the business exit planning process is the discovery phase. Here we evaluate the owner's personal readiness, financial readiness, and business readiness in order to create and prioritize an action plan. For personal readiness, qualitative and quantitative assessments should be looked at thoroughly. We do a series of exercises and assessments to understand where the business owner is and where they want to go. These can include a “values exercise,” where an owner can prioritize 50 value cards and narrow down their top ten values. We also use George Kinder’s three questions to gain an understanding of what is most important to the owner. Additionally, we utilize several tools to understand the owner’s initial preferences and personal suitability for various exit options. Finally, we take time to dig deeper so we can truly understand their short-and long-term goals.

During this phase, it’s important to have deep discussions about where one stands within the lifecycle of being a business owner. These conversations should cover topics of motivation, outlook, and attitude. Teasing out their vision for life after the business is another imperative dialogue to have. Ideally, a post-exit personal readiness plan would identify the personal attributes and benefits the owner currently receives from operating their business – purpose, challenge, social relationships, and so on. Taking time to detail specific activities for an owner to take on in their post-exit life that will address and fulfill those attributes can be beneficial in helping them avoid feeling empty or lost after the sale of the business.

A deep dive into the owner’s exit preferences needs to be sussed out. Are there strong preferences for key employees or family members to be involved in the business post-sale/transition, and what are the real reasons behind these preferences (legacy, fairness, etc)?

Assess Financial Readiness. A thorough assessment of the owner’s personal financial situation during this discovery phase is key. Accurate budgeting and cash flow analysis, in conjunction with a thorough analysis of their assets, liabilities, current estate plan, investments, and insurance coverages, can help identify any risks and gaps in their overall financial picture. For many owners, there may be little financial distinction between personal and business expenses. By deeply examining both, one can uncover the true level of living expenses and true level of business operating expenses. Fundamentally, this initial personal financial readiness plan will determine if the business owner has enough money to live on in retirement without selling the business. If they don’t, what would be the minimum amount of after-tax sale proceeds they would need to live comfortably? Whether from a personal, financial, or business perspective, during this process the owner should consider contingency plans in the event that a future business sale does not go through.

Assess Business Readiness and Attractiveness. Getting a business valuation from a qualified professional is a helpful starting point in understanding how ready the business is for selling. Typically, there’s a gap between the value the owner has in mind and the actual valuation. Owners are likely to have heard of a comparable business being sold for a certain amount or a high earnings multiple, and they may be anchoring their expectations to an unrealistic value given where their business stands today. 

Diving deeper into understanding the company’s operations and culture, strategy and vision, structure, industry dynamics, employee dynamics, core customers, supplier structure, brand promise, financial position, key performance indicators, facilities, technology infrastructure, and market position can help identify areas of improvement. Addressing these areas can increase the company’s future exit sale value.

A few imperative questions to answer are: what stage of the life cycle is the business in? Does it have growth potential, or is it in a mature or declining stage? Additionally, how dependent is the business on the owner? Oftentimes, an owner is leading many different business functions (sales, strategy, human resources, etc.), making the business less attractive to potential buyers due to overreliance on the owner. If identified, structural changes may be necessary once one has moved into the preparation phase of exit planning.

From Discovery to Preparation. With the discovery stage completed and personal, financial, and business readiness evaluated, along with a prioritized action plan in place, it’s time to gather a team of professionals who can bring successful outcomes to fruition. This team should include the business owner’s CPA, financial planner, insurance advisor, estate planning attorney, business attorney, transaction attorney, and business value growth consultant. Later in the process, an investment banker or business broker should be added. The optimal team members will have best-in-class skills and knowledge in their particular areas and should also have a collaborative mindset, focusing on bringing forward an optimal exit planning process and result.

Some owners prefer a team that is predominantly from one company, believing it will streamline complexity and save time. However, it’s unlikely the best-in-class advisors across diverse disciplines would all come from the same firm. This structure could stifle healthy debate and creative ideas. Moreover, specific experience in exit planning is a must to avoid potential pitfalls and landmines in the process. As the team is built, efforts should focus on de-risking the previously identified personal and business risks.

Addressing Personal Risks. During the preparation phase, the owner should take steps to mitigate a myriad of potential personal risks. This involves reviewing insurance policies to ensure sufficient coverage. For example, checking their level of umbrella insurance, which can help protect against frivolous lawsuits and potential gaps in home or auto coverage. Additionally, exploring asset protection strategies is crucial. These strategies might include maximizing assets in qualified plans, optimizing state homestead protections, separating real estate assets into LLC entities, and evaluating trust structures. Asset protection should be viewed as an ongoing process, rather than a set-it-and-forget-it transaction. If a buy-sell agreement is not yet in place for a business with partners, the terms, funding, and valuation should be reviewed and addressed. Finally, on the estate planning side, tweaks to assets to avoid probate should also be considered during this period. If the owner is potentially subject to Federal and/or state estate or inheritance taxes at death, the full spectrum of strategies and techniques should be evaluated. For example, in New York State, even a dollar of assets over 105% of the threshold estate exemption ($6.94 million per individual in 2024) could subject all of a person’s assets to estate taxation, as opposed to how only assets over the Federal estate exemption are subject to tax. However, with proper planning and carefully drafted documents, an estate tax could be avoided in situations where a New York resident’s estate assets are marginally over the exemption amount.

Rightsizing Investment Portfolio Exposures. To avoid potential risks in the owner’s personal portfolio, several tweaks might be made. First, optimizing the appropriate mix of asset classes and avoiding over-concentration in specific industries. Next, screening investments to ensure they are low-fee and tax-efficient, as well as ensuring the right mix of passive and active investments is being utilized. Additionally, they can ensure their investments are regularly re-balanced and maintain the proper balance of liquid and illiquid investments, while rightsizing the owner’s emergency fund.

Initiating Business improvements. In the preparation phase, addressing the areas in need of business improvements that were identified during the discovery phase can be the most impactful part of the exit planning process. This can be achieved through engaging business consultants, forming a board of advisors, joining peer entrepreneur groups, and/or initiatives spearheaded by owners themselves. A common framework for tackling value growth acceleration involves reviewing functional departments such as sales and marketing, leadership and planning, finance, and legal. Many owners believe that building business value involves increasing sales, making acquisitions, and/or cutting costs. However, this strategy can often backfire with unintended consequences. If done under the wrong framework, these initiatives can lead to issues with product or service quality, putting the company’s brand and market position at risk. Common areas addressed in this phase of exit planning include implementing policies and procedures, updating and implementing new technology, and conducting staffing assessments.

Improving the company’s accounting and finance function can make the company more attractive by reducing risk to potential future buyers. Key considerations include whether the financials undergo regular financial audits, the regularity of monthly reporting, and the implementation of best practices around financial controls. It’s also important to assess the level of sophistication of the reporting and forecasting function of the company, and whether it is based on simple revenue projections or if there’s a rigorous process to produce comprehensive financial statements. Additionally, avoiding regular restatements in financials is important. Effectively implementing these business improvements can result in a higher quality, lower-risk company with sustainable and predictable cash flows. In turn, this would create a business that is more easily transferable, potentially leading to a larger universe of buyers, and a higher valuation and exit multiple.

Owners should also strongly consider initiatives and training programs to develop their management team. Owner overdependence can lower a company’s valuation, so having the next generation of talent should be a high priority area. For those aiming to transition the business to family members, this process can be particularly tricky. Others may want to begin cultivating relationships with potential future buyers. Getting to know strategic buyers in their sector or raising their profile within the industry can be a helpful strategy down the line for some. 

Reassess Optimal Timing. Owners should work hand in hand with their team during the preparation phase to periodically reassess current exit timing from a variety of perspectives. This involves considering factors such as the industry progression of the business within the business cycle, exit multiples in the current capital markets relative to historical trends, and the level of reliance the business has on the owner, which, again, can impact transferability.

Having a post exit plan finalized, a business owner’s motivation should increase over time - especially when age and motivation are considered. As they age and health declines the ability to exit on a personal level declines. 

With many exit planning options to consider, and a multitude of areas of improvement to focus on, this process can be overwhelming. It’s best to make incremental progress, getting an early start on areas that have higher complexity and can take a long time to implement. For instance, numerous estate planning strategies that are focused on reducing tax and mitigating risk often require extensive analysis and implementation periods. Similarly, tax-advantaged structures like ESOPs and qualified small business stock (QSBS) can entail lengthy qualification and implementation processes, potentially requiring a conversion of the business entity type. Charitable giving strategies also warrant consideration in the final exit plan. Given the complexity involved with some strategies and techniques, exploring a menu of options early is desirable for owners with charitable interests. Moving through the majority of the exit planning process well in advance of deciding on a path provides owners with more options and flexibility, ultimately increasing their probability of a successful exit outcome.

Family business succession planning should also be initiated early and run parallel to the overall exit planning. Many potential issues will need to be addressed: how will next-generation children in the business versus those out of the business be treated in the estate plan? Is there a plan to retain non-family management within the business? How will conflict and disagreement over the strategy and operations of the business between the current owner and the rising generation be addressed constructively? Is the family business success ready to step into a leadership role? If not, is there a development plan to get them ready? How will the transfer of ownership to the next generation be designed? Will it be a fair market value sale, a gift, or perhaps will it be sold at a discount? If succession involves a purchase by family and/or non-family management, how will it be financed?

The final stage of exit planning is the decision phase. The optimal exit option will be determined by where the owner sits on the scales of financial and personal readiness. If they’re not ready personally or financially, then the most appropriate path would be to continue to focus on growing the business and increasing their personal savings. If there is an immediate need for funds, the owner can potentially take some money off the table by utilizing an ESOP sale, a private equity recapitalization transaction, or a management buyout.

If the owner is personally ready to exit – whether they no longer want to or can’t be involved in the business anymore – but are not financially ready to exit, the optimal scenario would be to sell the business to the highest third-party bidder. Conversely, if the owner is financially ready, but still enjoys working, they might consider gifting to family or charity, establishing an ESOP, or executing a management buyout. An ESOP can be an attractive choice for owners who want to take money off the table in a tax-efficient manner over multiple stages while rewarding employees and management with ownership. However, it may make the company less attractive to some future buyers. For owners who are both financially and personally ready to exit, almost all options are available.

Once the owner has chosen the optimal exit path, the exit planning team can help finalize the transaction by addressing structural, legal, tax, financial, and other considerations. Owners should be mindful of their goals and have a keen eye toward the details of the structure, as well as any personal and financial implications that may come as a result. When dealing with private equity, owners should do their fair share of due diligence on their potential buyer/partner. Some primary factors to evaluate include the private equity firm’s industry focus, whether they have an active or passive management style, as well as investment history – from company stage to geological location. Owners should be particularly mindful of the details of an earn-out structure, as it can often result in disagreement and litigation down the road. Additionally, owners should carefully review the terms related to representations, warranties, working capital, transition services, seller reporting (if financing is involved), non-disparagement agreements, and other post-closing obligations.

David Flores Wilson, CFP®, CFA, CEPA is a New York City-based CERTIFIED FINANCIAL PLANNER™ Practitioner & Managing Partner at Sincerus Advisory. Click here to schedule a time to speak with us.