Business Owners Need an Exit Strategy When They Are Ready to Retire

After Karen Bush cleaned out her mother's overstuffed home 18 years ago, she realized she never wanted to leave that kind of mess for her children. So she tidied up her own house and then helped friends do the same.

Bush, 56, eventually turned this into a business, Great Falls Organizers in Great Falls, Va., with Veronica Falkenberry, whom she met when their daughters played softball together. "We both realized we were doing the same thing but not getting paid. We looked into it and realized this was a viable service that many people could use," Bush says.

A decade later, the pair is beginning to think about retiring in the next four years, but they are uncertain about how to sell their business. "Really, the business is our expertise and our involvement with our clients," Bush says.

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This uncertainty is something small business owners often wrestle with. Even the owners of the smallest of businesses need to have an exit strategy and should not assume a lack of interested buyers. Because the business is often the owner's largest asset, the decision to sell has big financial ramifications. "Just waking up one day and wanting to sell your business at a moment's notice can be catastrophic," says Rick Miller, a CPA and principal of Miller Advisors, an accounting firm in Brentwood, Tenn. "You must have a plan to sell your business."

Clean Up the Books

Selling a business can take anywhere from six months to five years. Starting early gives you time to adjust, leading to a better sales price. For instance, Patricia Farrell, an attorney and partner at Meyer, Unkovic & Scott in Pittsburgh, finds that some small business owners don't have important documents, such as employee confidentiality agreements and vendor contracts, organized and available electronically. The company may not have the right insurance to protect the personal assets of directors and officers in a lawsuit. Farrell ensures all of this gets corrected ahead of time. "Think about it like selling your house," she says. "To get more money, you might have to spruce up the bathroom and take a look at the gutters."

You should also separate owner-specific business expenses, such as a company-paid cellphone or car. With these costs removed, potential buyers get a true picture of the company's finances, and you have a better idea of your expenses in retirement, Farrell says.

Consider having the business's finances audited, especially if you do the books yourself, says Jon Rubin, a middle market investment banker for family-owned companies and entrepreneurs at Westbury Group in Westport, Conn. An outside review by an accounting firm gives buyers more confidence in your company's performance.

An accounting firm can also produce a quality of earnings report. Although not a full audit, it validates the company's reported earnings and identifies onetime expenses and other adjustments to show a more profitable business. This also gives you an expert to refute any concerns the buyer raises during due diligence. Without that help, "it would be like arriving unarmed to a gun battle," Rubin says.

Pricing and Taxes

Advisers use different methods to price a company. One way is to compare the valuations of publicly traded companies that are similar to the privately held business up for sale. Another is to look at acquisitions of similar companies with publicly disclosed prices. A third method is a discounted cash flow analysis, which forecasts the value of the acquisition based on anticipated future cash flow, Rubin says.

Buyers generally base what they're willing to pay on a multiple of the seller's earnings before interest, taxes, depreciation and amortization, or EBITDA, says Stuart Smith, national director of business value strategies at Wilmington Trust in Wilmington, Del. Sellers with stronger fundamentals, such as loyal customers and better margins, receive higher multiples.

The sale of a business also has tax implications for the owners. Most small businesses organize as a passthrough entity, such as S corporations or limited liability companies, with earnings passed on to owners who are taxed at their individual rates. In contrast, C corporations pay taxes at the corporate level before any earnings are passed on to shareholders.

The proceeds from a sale of a pass-through entity are only taxed once -- when owners pay their personal federal income taxes -- rather than potentially twice for a C corporation (once at the corporate level and again when shareholders pay personal income taxes on their share of the proceeds), depending on the transaction's structure. That can make pass-through entities more advantageous for some business owners.

In general, sellers may also want to structure the deal so that more of the proceeds are taxed as long-term capital gains, which have a top rate of 20%. If the proceeds are taxed as income, the tax could be as high as 37%, depending on the owner's federal tax bracket. Whether to sell business assets or stock can be part of that decision. "The most common pre-planning task a seller should perform is a hypothetical calculation under each of those scenarios to see how the results can vary," says Kurt Piwko, a partner in the national tax office for Plante Moran in Southfield, Mich.

As you consider offers, the potential buyer's plans for your company may be a factor. If you want your business to survive you, don't choose a buyer who wants your company solely for the market share. Entrepreneurs hungry to grow your company may be more appropriate. Owners who care about their employees might consider selling the business to an employee stock ownership plan, or ESOP, Miller says. The ESOP, which acts as a retirement account for the employee-owners, is overseen by a trustee, who would negotiate the deal. Retiring employees receive a payment based on the value of their shares.

The form of the payout can also vary depending on the buyer, Rubin says. For instance, buyers that are large publicly traded companies or privately held firms that make strategic acquisitions often prefer all-cash deals. If a private equity firm is the buyer, you're more likely to get some cash upfront as well as some rollover equity in the new company. An investment banker or a business broker can help you explore different options and identify potential buyers. For companies worth at least $5 million, Rubin recommends hiring an adviser that is registered with the Financial Industry Regulatory Authority.

What Comes Next

Selling a business can be like "the grieving process," Smith says, noting that some sellers get cold feet and back out of the sale. "For many of these owners, they have built their business up with blood, sweat and tears," says Michael Lindquist, a private client adviser at Bank of America Private Bank. It's not easy to let go.

Moving on may be a lot easier if you know how you'll fill your time. Many of Lindquist's clients wait a few years before starting another business. Some continue working for the company as an employee or independent consultant for a set number of months after the sale of the business is final. If that's your plan, work out those details during negotiations, but bear in mind it may be hard to watch someone else make decisions for the company you built.

About seven years ago, Mike Glicksman, 64, of Wyckoff, N.J., decided to sell his company, which manufactured covers for flat screen televisions and keyboard protectors. He had run the business since the early 1980s. An employee who had worked with Glicksman almost from the beginning bought the business and paid for it over six years. Glicksman says he thought the new owner would need him to stay heavily involved as an adviser, but that wasn't the case.

Initially, Glicksman struggled with what to do next. He bought a company that mailed coupons to consumers but dissolved it after two years. Eventually, he turned to volunteer work, including serving as vice chair of the northeast New Jersey chapter of SCORE, a national network of mentors who work with other business owners. Now he spends about 25 hours a week volunteering and finds it extremely rewarding. "Owning your business kind of identifies you," he says. "Before selling, really have a plan. Think about what you want to do next, and actually write it down."