Business Exit Strategies
After a while when the business is successful you may want to exit to rest or to cash on it and do other things or start another business. You may also want to exit a failed business and quit the business altogether. For a successful business, you need an exit strategy; in fact, an exit plan is necessary as you start the business because this has a bearing on how you start and run the business. To be able to sell an ongoing business for value, you will need to focus on things that will create value over time during set up and operation. The value of a business is the estimate of its worth. A business has a high value if it has a healthy bank balance, valuable assets, a higher profit margin, and strong promising profitable and enduring future.
A higher valuation is important for the following reasons:
- A higher value makes it easy to borrow money.
- A high-value business has a higher share price and higher dividend payment, which are important for shareholders.
- A higher value makes it easy to attract a buyer and a good price in case of sale of the business.
- A valuable business is, in case of sale of shares, able to raise more capital by selling only a few shares meaning you do not need to give up a higher portion of ownership to raise the money you need.
There are two main ways of creating value in business:
Structures and systems
You require to create and operate the business with modern management structures, policies, procedures, rules, automated and digitized self-executing systems that require very little employee discretion and intervention to perform a task. In addition to these, you need to have a pool and a pipeline of knowledgeable, skilled and competent motivated employees with well-defined staff development and succession plan. The systems and operations should be well oiled and be system-based as opposed to people-based operations that over-rely on people and the owner’s constant presence and close supervision to function well and deliver.
Value and goodwill
You need to create value and goodwill in your business. You do this by creating a valuable self-selling product or service. It needs to be a product or service that is useful and solves people’s problems. The valuable product is enhanced by branding your products and services, creating a loyal customer base through branding and great customer care, having a great location, digitizing and systematizing the business-for effectiveness, efficiency, great customer experience and to be able to run without the owner’s supervision. Also, you need to systemize and document the operations such that all steps and performances can be repeated with the same consistent outputs effectively and cost-effectively no matter where and by whom.
Exiting an ongoing successful business
You can exit a successful business in several ways that include taking free cash, an outright sale, and partial or complete selling shares. Before starting the process of exit, you may need to value your business to have an idea of its worth. For this, several methods can be used:
Asset Approach Method (Book Value): The asset approach takes the view that a business is the total of tangible and intangible assets and liabilities it owns and owes. The value of a business is, therefore, the difference between current values of assets and its liabilities (Assets – Liabilities = Net Worth). Another way of looking at the value of a business under the asset approach method is to determine how much it would cost to create another business like this one that will generate the same economic values for the owners.
Market Approach Method: The market approach method takes the principle of a willing seller and a willing buyer. The price is the value that a buyer is willing to pay and the seller is willing to accept for the business. The approach also relies on the signs from the market as to what is the value of similar businesses in the market.
Income Approach Method: This approach considers the value of the benefits that might accrue from a business. It attempts to answer the question, if I invest time and money into a business, what economic benefits might I get from the business and by when? In a business, benefits accrue slowly over time in the form of cash flow generated by operating the business profitably. Because of the period, the income that the business is expected to generate over its existence has to be figured out and transformed into the present. To achieve this translation, the income approach uses two techniques known as capitalization of earnings method and discounting of earnings method which is also known as the net earnings method.
Capitalization method is so-called because it capitalizes expected earnings using a given capitalization rate to arrive at a value. For example, think of a business that has been making a net operating income of US$80,000 annually and is expected to continue to make about the same for the foreseeable future. An investor interested in buying such a business may compare this annual return of US$80,000 with other investments that could earn the same amount. The investor can, for instance, invest in Treasury bills instead that pay 8% annually. To earn US$80,000 annually at the rate of 8%, one would have to invest US$1,000,000 (i.e.800,000 ÷ 8% or 0.08) in Treasury bills. This, therefore, means the business earning US$800,000 annually is worth US$1,000,000. The capitalization rate depends on the risk tolerance of the buyer and what the buyer views as an acceptable return. Commonly applicable rates range from 15% to 25%.
Discounting of earnings method relies on present value principles. The present value principle is the idea that a unit of money now is worth more than the same unit in the future because of money’s ability to earn interest immediately it is received. To determine the value of a business using the discounting method, annual net income from the business is projected over several years that the entity is expected to be in business and earning income. The residual value of the business at the end of this projection period is also determined. The projected net income year by year and the residual value of the business are discounted to the present using an appropriate discount rate and predetermined present value table. The sum of these discounted values represents the current worth of the business. Another variation of the net earnings method uses the rule of thumb. In this method, it is usually assumed that a business should sell for about three to five times its annual net earnings. If for example, a business has been earning a net profit of US$80,000 per year, it could be expected to fetch a price of US$240,000 –US$400,000.
Goodwill is the intangible and immeasurable aspect of a business that allows the business to do and have things that attract customers to the business and in the process make the business very valuable. The aspect usually include facets such as a good location, protected intellectual property rights, unique processes, brand status, good reputation, a self-selling product or service, gifted and loyal employees, great customer care, and excellent relationships with stakeholders such as customers, suppliers, service providers, society and regulatory authorities or government.
Exit methods for an ongoing successful business
Methods that can be used to exit an ongoing successful business include:
Free cash: Free cash is about building the business by reinvesting profits into the business until it is doing well. At this point, you can reinvest only what is necessary and take the rest of the profit (free cash) for other personal uses.
Management or Employee buyout: This is method entails selling your business to your managers or all employees through various loaning schemes or employee stock ownership plan.
Merger or Acquisition: You can merge your business with another similar business or sell the business and exit in the process by selling your shares to the merging or acquiring company.
Public share issue (IPO): This is where a company issues a prospectus inviting the general public through newspapers to purchase its shares. The first issuing of shares in this manner is technically known as Initial Public Offer (IPO).
Offer for sale: This is a method where a company offering a new issue of shares sells the entire stock of shares to an issuing house, and the issuing house will bear the risks of selling the shares to the public. If all the shares are not sold, the issuing house takes up the balance.
Private placing: This method involves issuing shares to selected financial institutions, other large clients or members of a club instead of making an offer to the public. A new business or start-up can make use of this method without having to meet stringent conditions.
Rights issue: This is a kind of a right where the company gives each existing shareholder the first option to buy a stated number of additional shares of the company that are being issued at a price lower than that listed in the stock exchange.
Stock Exchange introduction: This is normally used to allow a company that already has issued shares to private shareholders to list in a recognized stock exchange and allow existing private shareholders to sell their shares to the public.
Exiting a failing business
It is not uncommon for a business to struggle and eventually fail. Many startups do indeed falter and many eventually fail. If you have a business like that, it may be difficult to sell at a good or fair price. You can exit a businesslike this through liquidation or bankruptcy processes. These processes are governed by laws and these laws differ from country to country. However, business laws have common principles that work as follows:
This is a process where assets of a business are, through a voluntary or court decision, sold to pay debts and wind up the business. Liquidation happens in several ways:
i) Members’ or Shareholders’ Voluntary Liquidation (MVL)
This is a procedure that is voluntarily initiated by owner or shareholders of a solvent business and assets of the business are sold by an appointed independent overseer to pay creditors in full and shareholders or owner is paid if anything is left after the sale.
ii) Creditor Voluntary Liquidation (CVL)
CVL is also voluntarily initiated by the owners (shareholders) of the company without a court order and is only used for a business that cannot pay its debts and is no longer able to trade viably. Like MVL, a liquidator is appointed to oversee the process. This process is similar to what is available in Chapter 7 bankruptcy laws in the USA.
iii) Compulsory Liquidation
This type of liquidation is usually court-ordered when a creditor or creditors petition the court to wind up (place in liquidation) a business that owes them money which it has not been able to pay.
Bankruptcy is the state of inability by an individual or an entity to pay debts that are due (being insolvent). Although this explanation implies an insolvent individual or entity is also bankrupt, insolvency and bankruptcy are not synonyms. An insolvent individual or entity is not bankrupt until declared so by a court of law through a petition by the creditors or the debtor’s voluntary submission to the courts for protection. Bankruptcy is a status that comes about through a legal process, which ends in a court order declaring the debtor bankrupt, and the courts providing a resolution scheme as well. The process of initiating bankruptcy proceedings is known as filing for bankruptcy.
Depending on the prayers of the petitioner and court’s decision, bankruptcy proceedings can lead to liquidation and winding up of the business or a scheme where the business is allowed to continue to operate and restructure to create plans to find new ways to increase revenue and cut costs to return to profitability and service its debts. Such a scheme is similar to what is available under Chapter 11 of USA bankruptcy laws. It is also similar to what other jurisdictions refer to as putting a business under receivership or management. Another variation of this recovery-based bankruptcy scheme is where a business is allowed to continue to trade but provide a workable debt repayment plan. Chapter 13 of USA bankruptcy laws allow for a scheme like this.