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© 2012 Englander, Leggett & Chicoine P.C.
Exit Strategies for Small Business
Exit Strategies for Small Business
When we start our businesses, we think about how to form it,
finance it, run it, and grow a client/customer base. What we don’t
always think about is what will happen to our successful business
once we are ready to retire. This paper highlights various ways
that small business owners may extract the value that they’ve built
into their business as they transition into retirement.
Note: This article is based on my experience as an attorney and my
opinion only. It is not intended to be an in- depth legal or
financial analysis of the exit strategies discussed. It is also not
intended for medium to large businesses; therefore, I have not
included discussion of other exit strategies that may be available
to these businesses, such as becoming a publicly traded company.
This article does not constitute legal advice.
Introduction
Exit Strategies for Small Business
Probably the easiest way for the retiring owner to leave the
business is an outright sale of ownership interest (i.e. stock) or
company assets to someone you don’t yet know. This kind of “arm’s
length” transaction between a willing seller and a willing buyer is
the way you will most likely be paid fair market value for your
business–especially if there are multiple possible buyers–and to
put more value into your retirement relatively quickly.
Whether you’ll be able to find a willing arm’s length buyer depends
on a number of factors. This type of sale is most likely to occur
if:
• The business is easily transitioned to new owners • without any
disruption in your business’ profitability. • The business offers a
systematized, consistent • product or service. • The business is
not dependent on the owner’s • participation in it to succeed. •
You are either the sole owner of the business or a • majority owner
who can bring other lesser owners • to the sale in order for the
buyer to purchase the • entire business.
This type of transaction may involve a business broker who looks
for potential buyers–just as a real estate broker assists people
selling real estate. Brokers can play various roles depending on
your needs. They can access your business and help get it in order
for a sale or they can simply introduce potential buyers to your
business. This can also be helpful in setting a reasonable price.
The costs of the broker’s services depends on the scope of the work
performed and whether the broker is seeking a fee for services
and/or a percentage of the sale price. Since a broker’s
compensation is often tied to a percentage of the sale price, they
are incentivized to get the best price. Once a potential buyer is
found, there is typically a confidentiality and non-use agreement
put in place so that a buyer investigating your business for
acquisition doesn’t use any of your proprietary information
without
Arm’s Length Sale
would enhance the
held in escrow until end of
the year audited financials
were completed, with a
mechanism to adjust the
consultant for public
time following the closing
business and client
Exit Strategies for Small Business
having completed a transaction. Following the initial review of
your business, the parties (seller and buyer) will negotiate an
outline of the deal. If the lawyers haven’t been previously
consulted, this is when they need to be brought in. This step
involves the drafting of a term sheet detailing the terms of the
sale.
There are a variety of ways to structure a sale and many details
and nuances that may change during the transaction process as it
unfolds. Some of the bigger decisions that will be made are:
• Will the buyer purchase your ownership interest or the assets of
the business? • Will payment be made in full at close or purchased
over time?¹ • Will some of the purchase price be held in escrow
and, if yes: how much, for • how long, and for what
contingencies?
The purpose of escrow is to provide the buyer security in case the
business doesn’t turn out to be all that the seller says that it is
or certain classes of liabilities arise after closing (i.e. tax
liabilities as a result of an audit). If the purchase price is paid
in two or more installments, the later installments can be adjusted
(often only down) if the financial statements for the business
don’t meet expectations.
Once the term sheet is entered, the buyer, seller, and their
respective attorneys and accountants go to work on the transaction
details. This is the due diligence phase of the transaction where
an in-depth analysis of the business is undertaken. How much of the
various due diligence tasks are done by hired outside professionals
or inside personnel will vary depending on the sellers’ and buyers’
inside expertise and resources. Due diligence includes:
For accountants:
• Review of financial statements, including tax returns • Tax
analysis of how the sale and the business are structured
For attorneys:
• Review of contractual relationships (clients, suppliers,
landlords, etc.) • Review of business status (business records,
statutory filings, etc.)
¹ Any time there is a sale phased over time from seller to buyer,
which may occur in all of the approaches discussed in this article,
often the seller will be concerned about how the business will run
and who will be making decisions for the business during the
transition period. Many specific concerns may be addressed in
governance documents (the incorporating documents and other owner
agreements, such as stockholders voting agreements) defining how
the management team will be appointed, who they will be, and
perhaps, providing guidance on how key decisions should be made.
Not all circumstances can be perfectly anticipated in these
documents but agreements can provide direction.
Arm’s Length Sale
Exit Strategies for Small Business
Based on the agreed upon term sheet and any variances that may
arise during due diligence, the transaction documents will be
negotiated and drafted including:
• Financial terms of sale • Representations and warranties •
Holdback/escrow • Employee matters • Non-competition and
non-solicitation provisions • Indemnification • Other terms and
conditions
Depending on whether the seller is going to stay with the business
following the transaction, there may also be:
• Employment agreements • Changes to the governance documents
(Charter, Bylaws, Operating • Agreement, etc., as applicable)
Based on tax and legal advice there may even be a complete
restructuring of the business (i.e. reorganizing the business under
the laws of a corporate friendly state like Delaware) or other
changes.
All of these efforts can cost the parties tens to hundreds of
thousands of dollars. Generally, a higher valued business equates
to higher transactional costs.
Arm’s Length Sale
Exit Strategies for Small Business
Many small businesses can’t (or don’t want to) engage in the
process of a true arm’s length sale, with its typically high
transactional costs (see above). It may be that the costs don’t
balance out against getting the best value for your business, or
the business is not well-suited to attracting an interested arm’s
length buyer.
In such a case, a target buyer may be someone you know or who is in
your line of business. This sale will be very similar to an arm’s
length sale, but because the buyer knows you and/or your business,
you may decide on price through discussion only, instead of through
an independent financial analysis of the business. The buyer may be
willing to forgo some of the extensive representations and
warranties, due diligence, the hold back of escrow, etc., that are
typical in an arm’s length transaction because s/he is familiar
with your business or has experience running the same type of
business and knows what to expect. This “arm’s length light”
transaction provides the benefit of savings on transaction costs
(reduced accountant and attorney fees, etc.) but may not get you
your highest and best value for your business.
Arm’s Length Light
business to the
experienced owner of
agreement only to those
business being sold.
Exit Strategies for Small Business
For businesses with multiple significant co-owners (two or more
approximately equal owners) who also work at approximately equal
levels within the business (act as partners regardless of the form
of entity) there may be a desire or need to keep the business
interests within the existing ownership structure. In this case,
the sale can be to the business entity or to the co-owners and can
be done a number of ways.
Such sales:
• Can occur upon retirement, death or disability; • Can occur
automatically or at the option of the • business entity or retiring
owner (or his/her estate); • May be paid for by insurance, profits,
or separate • financing.
The important message here is that there are many choices in
structuring how you and your co-owners may want to handle the
retirement of one of the owners. Retirement, disability, death, or
decisions to move or change career paths are also events that can
be handled differently. ² The terms of sale for purposes of
retirement do not have to be the same as for a voluntary job
change. While included here as options for retiring owners, in a
multiple-owner business, these matters should be thought about,
discussed, and agreed upon at the time the co-owners decide to go
into business together--not at the time the business is confronted
with the event.
Multiple Co-Owners
² Many of the strategies discussed in this article may also benefit
an owner’s estate in less pleasant scenarios than retirement;
however, such scenarios should be specifically thought through and
planned for before they happen.
Case History: Selling
to the Business
owner, the business will
purchase that owner’s
co-owner moves or
obligation -- to purchase
each case, there are
pre-agreed terms of sale
and an agreed upon
method to value the
the event.
Exit Strategies for Small Business
Family
If you’re lucky enough to have children who want to work in your
business and are interested in carrying it on, then transitioning
the business (or your interest in it) to those children may be a
good option for you. You will need to work with your advisors
(accountant, business attorney, estate planner) to determine how
and when to transfer your interest (i.e. through gifts in whole or
in parts during your lifetime, in trust, or in your will). This is
a very different type of approach to an exit strategy than the
others discussed in this article. It is not a sale of the business
per se but a transfer of your interests in the business to your
children and is likely best done through an estate planning
vehicle. However, in addition to consulting an estate planner, the
business’ attorney should be consulted to work with you and your
estate planner to consider how proposed changes in the ownership of
the business may impact your desires and goals for running the
business now and in the future.
Employees
Bonus Stock ³
Whether or not you have children who may become owners of your
business, you may have a group of employees or a few key employees
4 who are interested in taking over your business. In this
situation, assuming the employees are not in a position to buy your
interest as in an “arm’s length light” transaction discussed above,
you can adopt a plan over a period of years to grant them stock as
part of their compensation package. During these years, you may
grant less cash compensation to them (extracting that value for
yourself) and, by granting these employees stock, increase their
ownership position over time relative to yours. There is, of
course, a tipping point here when the employees will become the
majority owners of “your” business and you will be a minority
The Next Generation
³ This strategy is distinct from Employee Stock Option Plans
(ESOPs), which are heavily regulated by federal law and can be cost
prohibitive to small businesses to set up and maintain. Also, in
order for ESOPs to have value to the employee there must be a
mechanism for the employee to monetize their interest once they
become owners. There must be a readily available market for the
interest, such as stock in a publicly traded company or an
obligation on the part of the business to buy the employee’s
interest at some predefined point. 4 These few key employees could
be co-owners that have an existing small interest in the
business.
Case History: Passing a
Business to the Next
firm employing himself,
young minority owner. For
two younger employees
to the father. Over time,
the father’s interest in the
business is diluted and the
younger employees’
trust for the benefit of
first his wife and then his
children. It is anticipated
retirement he will own a
minority interest and at
business and/or other
leverage the business to
plan will be reviewed
every 3-5 years and
adjusted, if necessary, to
continue to meet the
Exit Strategies for Small Business
owner. You can still retain some amount of control through the
adoption of governance strategies; but typically, the day-to-day
decision making will transition to others in the business.
In anticipation of your becoming a minority owner and fully
retired, you can combine this approach with an agreement that upon
your retirement either the business or the then majority owners of
the business will buy your remaining interest. There are
innumerable ways to value that interest and the method of that
valuation should be agreed upon in advance.
Cooperatives
Some businesses with a reasonably large number of long-term
employees have transitioned ownership to the employees as a whole.
An employee cooperative provides an ownership interest to at least
a majority of all employees. In the typical cooperative, financial
ownership is separated from share ownership. The corporation is
governed equally by the employee owners and profits (after retained
earnings) are allocated/distributed based on the relative
contribution of labor that an employee puts into the business. This
is not a particularly common exit strategy for most businesses as
its requires the right retiring owner (one who is willing to be
paid out of profits of the corporation over a long period of time),
the right employees (who are interested in long- term employment
and willing to work with their co-employees to run the business),
and is a business of the type that would run well with this type of
structure (farms, credit unions, natural food stores).
The Next Generation
Exit Strategies for Small Business
For those businesses that practice one of the licensed professions,
additional considerations come into play when looking for your
buyer. Many of these types of businesses can only be owned by
similarly licensed professionals (such as doctors, lawyers, and
accountants). Also, these businesses are typically successful due
to client loyalty to the individual service provider.
There are two approaches you can take to retirement. One is to
extract as much value as possible from your business during your
practicing years and have no expectation to “sell” your practice
later in life. If the right buyer comes along who is willing to pay
you something for your practice, even though they may not retain
any of your clients, then there’s some unanticipated money you can
add to your retirement.
Another approach is to plan to transition your practice over a
period of years to another professional. Working closely with
another professional who intends to buy your practice allows your
clients to come to trust that professional as they have trusted you
and increases the likelihood that the buyer will retain the
clients. This approach has a great many challenges, including how
long the transition will take, how to value the business, and what
happens if your clients don’t like the would-be new owner (or
worse, they like the would-be new owner so much that you lose your
clients before you’re ready to retire).
Special Considerations for Professionals
Case History: Selling a
to his attorney son-in-law
business financials. No
Exit Strategies for Small Business
Once you’ve decided that you would like to retire in a five to ten
year time period, it is time to meet with your advisors to see
which option, or combination of options, might work best for your
circumstances. Be prepared to engage in a long process of exploring
multiple options until you find the one that works for you. This
article provides a variety of ways a retiring owner may be able to
transition his/her business and they are not all necessarily
mutually exclusive of each other. Some mix of approaches might be
best for you. In addition to finding the right buyer, there are a
number of financial and legal considerations that are involved in
each of the strategies discussed in brief in this article. These
exit strategies may take years to accomplish from decision to
conclusion.
Conclusion
Exit Strategies for Small Business
Debra Leggett is a partner at Englander, Leggett & Chicoine,
P.C., a Boston law firm with particular expertise in business
relations, employment law, real estate transactions and land use,
appellate litigation, health care and human services, and records
management. Attorney Leggett’s practice is focused on business law,
corporate representation, intellectual property and health care.
She has provided legal counseling and representation to a wide
range of corporations and entities, from large for-profit and
not-for-profit entities, to small start-up business and charitable
organizations. For more information, please visit
www.elcpc.com.
About the Author