Exit Planning Strategies For Your Business

It may seem counterintuitive, but an exit planning strategy should start from day one. When you prepare for your business departure in advance, you can minimize taxes at the time of sale, as well as provide a smoother and more secure transition for your replacement.

Some elements of an exit strategy, such as how to value your ownership in the business, should be determined from the get-go. Others, like choosing and training a replacement, happen further down the road. Understandably, though, people focused on growing their business tend to overlook these steps.

“It’s really important to be able to address the unexpected developments in the life cycle of a business,” says Jeff Van Winkle, vice chair for communications for the National Small Business Association (NSBA). This is particularly important for small businesses in the construction industry, which tend to be owner-managed. “When ownership changes, that means management changes.”

Getting started
Exit planning strategies should start with a conversation between owners about the big picture to determine what they want to get out of the company, whether they’re sole proprietors or share ownership. During the launching stages, they should discuss what level they’d like sales to reach, how many employees they hope to have, and when they plan to retire.

The next step is planning the exit of ownership. A shareholders agreement, or buy-sell plan, outlines key financial details such as what the business is worth when you start, and how your share will be valued when you leave.

What’s at stake
Some owners simply plan to build up a cash reserve over the years, then close the doors and liquidate any remaining assets. But laws are complicated, and one purpose of an exit strategy is to avoid unanticipated disputes. A well thought out exit plan can protect you against certain unknown factors—like a partner who suddenly leaves, tries to buy you out or doesn’t live up to your expectations.

Peter Merrill specializes in small business mediation and arbitration as the owner of Construction Dispute Resolution Services, LLC in Santa Fe, N.M. He says he’s seen many building businesses shut down because owners weren’t familiar with laws that transfer ownership to spouses due to an accident, death or other unexpected event.

Therefore, some owners buy life insurance to cover the cost of buying out a partner’s ownership interest, should the need arise. That’s what Merrill and his partners did when they launched their kitchen design business more than 30 years ago. Though they never used the insurance, he says he still found value in having it.

Revisiting your plan
Some aspects of an exit plan occur closer to the departure. As you near your departure, you might start to consider potential replacements from within the business. Also an attorney for Grand Rapids, Mich.-based Clark Hill PLC, Van Winkle suggests using annual accounting meetings as an opportunity to discuss any new developments with your accountant and partner.

For business owners, their company serves the same function as a 401k plan does for an employee—it’s the source of funds for retirement. As such, Van Winkle recommends owners revisit their plan five years before they anticipate leaving the business in order to determine how to maximize the value of the asset.

“At that point, they should start to carefully assess how to deal with depreciated assets as well as significantly appreciated assets,” he says. “Also, any significant purchase by the business should involve obtaining suitable tax-planning advice.”

That means considering the tax implications of retiring, as well. For example, liquidating any remaining assets may leave you with a larger tax liability. So if your assets have increased significantly, your tax burden could be minimized through certain measures, like selling ownership interest rather than assets.

Unexpected exits
Of course, not everyone knows when they want to retire. A few years ago, Merrill had to leave his kitchen design business in New York due to relocating to the southwest. Merrill spent several weeks familiarizing his partners with hiring practices, purchasers and other aspects of the company.

The original buy-sell plan made for a smooth transition, and Merrill hired additional designers to ease the process. It also helped that there were detailed procedure manuals and products files in place.

Maintaining the image
With so much else to worry about, public relations might be overlooked. But the business relationships you’ve built up over the years could help keep the business afloat in your absence.  

“I did a tremendous amount of networking, and we got a tremendous amount of business from that,” says Merrill. Before leaving, he introduced his partner to builders, remodelers, installers and homeowners and familiarized them with local industry groups.

“Somebody has to maintain your presence so [your contacts] know you’re supporting the industry,” he says.