Ep. 01 - How To Choose Your Best Exit

Statistics show that 83 to 90% of business owners have no business exit plan whatsoever. And only 4% of the lower middle market business owners have a formal life after ownership plan. As a business owner, it's your duty to keep your business running long after you retire. You also need to know what your endgame is once you've set everything aside. In this episode, Dr. David Gruder and Jason Tuzinkewich explore the challenges business owners face when choosing their best exit. Find out why you shouldn't just sell your business for money. Discover your very own life after ownership plan. Learn all of this and more in this episode of Boosting Business Value.

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How To Choose Your Best Exit

What To Consider When Selecting Your Best Business Exit Option

In this episode, we're going to explore what to consider when selecting your best business exit option. 

Thank you. I'm excited to be talking about this subject. It's a great place for people to start when they're thinking about their business as a retirement plan and as preparing themselves for the next stage of life. To kick things off, I wanted to get into some of the scary statistics. First and foremost, the Exit Planning Institute runs a study annually. Consistently, they find out that 83% to 90% of business owners have no exit plan whatsoever. This becomes truly catastrophic if they fall into one of what we call the five D's. If you play dodge ball, you might be thinking dodge, duck, dip, dive, and dodge.

In business, we're talking about Death, Divorce, Disability, Disaster, or Disagreement between partners. Any of those things could dramatically change the landscape of business ownership for you and your family. This is why we want to make sure that people start to consider a plan early on. In that plan, we want to talk about when do you know that it's time to sell and how do you deal with risk and negotiation and how you can start setting yourself up for mitigating risk and positioning a strong negotiation early on.

Those stats are incredibly frightening to me, 83% to 90% of lower middle market business owners don't have an exit plan. What you've described around the five D’s, I'm sure our readers can relate to those easily because they're common sense once they're pointed out. Another scary stat is that only 4% of lower middle market business owners have a formal life after ownership plan. That means 96% of business owners don't have a formal life after ownership plan. The good news in all of that is that if you're among the 96%, then you know you've got a lot of company.

You're not alone.

No, indeed not. Developing that kind of plan beforehand is something that provides you with huge advantages. We want to unpack those advantages. The first of those is that when you have a life after ownership plan that's yours that you've developed and embrace and look forward to, it's your insurance policy against seller's remorse after you've succeeded at exiting. The reason that's important is because the prospect of seller's remorse undermines business owners’ abilities to follow through with their exit plan.

Jason, I know you've seen plenty of situations and I've seen some myself where an owner says, “Yes, I'm ready to exit.” Let's say it's a merger and acquisition situation where they're going to sell their business where a buyer is found who's a legitimate buyer and is prepared to buy at the price or even above the price that the owner wants to sell for, and then the owner undermines or sabotages the sale at the last minute. Oftentimes, that undermining or sabotaging is connected to their terror over what their life is going to be after they're no longer the owner.

I'm going to hit you with another scary stat here. Ninety seven percent of lower middle market M&A transactions that fail to close are destroyed by the seller not being able to let go at the last minute. 

That 97% is very much in line with the 96% stat. We're not making up these statistics. The information is there and it's known widely in the M&A world. The problem is that even though it's known inadequate steps, if any, are taken to prevent these avoidable upheavals from occurring. Another advantage of developing and a life after ownership plan is that in resolving family or partner issues ahead of time, you've removed crucial blocks that can prevent your exit plan from succeeding. 

Let's not forget that these are scary conversations. We're talking about a business owner thinking about what he's going to do when he or she is no longer a business owner. We're talking about the eventualities of old age and death and disability, things that we don't want to deal with. Don't beat yourself up for not having these conversations. If you're a part of the 96%, this is a hard thing to get going. That's why we like having the doctor on the couch with us. 

Thank you. The point of that is that these things that we're unpacking with you, these things that can undermine success with an exit are avoidable. With the right facilitation, planning, and assistance, these things can get resolved and addressed before they have an opportunity to create problems. A third reason or advantage for having a life after ownership plan is that preparing beforehand to embrace your post exit lifestyle change can do the same thing that preventing seller's remorse can do, which is that it can get the owner excited about their next chapter.

It gives them the clarity that they're seeking in order to have the internal permission to move forward with exiting. Connected with that is one of the biggest things that Jason and I have both seen in owners who get wet feet and stage fright around exiting, which is that many owners, especially owners of lower middle market businesses, they've put many years of blood, sweat, toil, persistence, devotion, and oftentimes, sacrifice into building their business to the point where it can be sold, that they have inadvertently built their sense of self around the business.

What that means is that when they consider the possibility of exit, no matter how strongly part of them wants to follow through on exiting, they're terrified that they won't know who they are after they are free of this business that has been their baby, the child that they've nurtured and grown up into sellability or their exit ability, no matter what the exit plan happens to be. Ahead of time, expanding your sense of self beyond over identifying with your business is what makes it possible to more easily and happily let go whenever the time does come to activate your chosen exit plan.

That's a beautiful stage setting for the rest of the conversation. I appreciate that. We can't state enough how hard it is, even for ourselves as business owners. I talked to my financial advisor. He asked me, “When do you want to retire? What age?” I'm like, “Do I have to?” I can relate to the idea of not wanting to let go and feeling like this is what keeps me young, but there's a family outside of work.

There are hobbies outside of work. Yes, you can only golf so many times in a week before it starts becoming mundane, but there's life outside of work. The earlier you start to explore what that means for you, the easier it will be to make that transition. There are a couple of things that business owners don't realize about the transitional process as well, that I want to make sure that we get out right in front of.

First and foremost, how long a transaction takes. I can tell you that I meet a lot of business owners that wait until they're burnt out. They're tired. They can't bring themselves to be excited about work anymore. They want out. Selling a business and getting the appropriate value and legacy protection for the business takes time. The average M&A transaction takes between 9 and 18 months. I've had some that took longer because we had to find the right buyer to take over the business and run it in an appropriate way.

I've had a couple run shorter, but 9 to 18 months is pretty standard. When you're looking at this, this is something you need to get out in front of and start way earlier than you think that you want to leave. You're also likely going to have an extra year on the backside of transitioning out and transitioning the new owners in. 9 to 18 months to close a transaction, another 12 to 24 months of transition period, you're looking at a long-term investment to exit. Most business owners feel like this is one of those things like selling a house. It's obviously more valuable real estate than a house, but it's the same thing, you list it, people show up, and you get to choose the offer that you like the best.

A good business exit is more of an active process. You identify who good buyers are. You determine what the business needs to get to that next level without you guiding the ship. You find good representation to actively seek out the best fit for the next stage of the business, as well as giving you the peace of mind to leave knowing that it's in good hands. 

It ties into the blocks that prevent owners from participating in the selling process beyond what we were covering before, because what we touched on earlier was how many business owners kill business deals because they don't fully realize they're not ready to let go of the business. In terms of participating in the selling process itself, most business owners don't end up selling to the highest bidder. Sometimes that decision is values-based because the highest bidder is not necessarily the best fit, but also, selling is an emotional process. We are not Mr. Spock. We're not Vulcans to draw on a Star Trek analogy where we are not as human beings 100% logical. We are also emotional.

If we care as most lower middle market business owners do about our personnel, the people who will continue to work for our business once we've sold it, we want a buyer who's not only going to buy for the price that we want to sell the business for and that we have worked to ensure that the business can be sold for.

We also want a new owner who is going to cherish, care for, and retain the personnel that we've nourished and developed into being highly valuable to the business, those personnel who want to stay with the business after acquisition. We need to be prepared for how we're going to deal with the emotions and values-based decisions that are part of successfully participating in the selling process itself. 

I'm glad that you brought back that emotional component because it's such a big deal. You don't think about it until you're in it, but this is the single largest financial transaction of most business owners’ lives. It is the emotional stepping away from a huge part of your own identification of yourself. You're worried about, is that financial transaction going to be enough to provide for my family and my future, the way that I want to?

Did all of that blood, sweat, and tears pay the right kind of dividend at the end of the day? There's a lot to unpack there. The more that you have a structured, detailed plan that you walk through and that you've had time to marinate on, the easier it is to let go of some of that emotional baggage and focus on the logical side of things. I'm glad you brought that up again.

I’m glad you added to that, all of the things you said, because that rounds out the picture. 

It's a big picture. This is why we want to excite people to start the hard conversations and the plan. To get out ahead of this, 5, 10 years. You could say, “There is not an exit and my horizon, but let's start planning just in case.” Business owner exits their business, whether it's standing up or laying down. We like the standing up side. We like jumping around the side and having fun. One of the things that got me into M&A transaction advisory is that I started and exited two businesses of my own. I did a horrible job. I didn't know what my options were. I didn't have a plan. I got tired of one project, so I sold it. I started another project. I had a family emergency and I had to leave my business preemptively.

After I was done with those two businesses, I was looking back and saying, “I don't have the right equity and capital to show for all this work. What was it for?” I learned about M&A and I started learning that there are options. Now I'm a super evangelist for making sure that people know there are options because I'm like, “This could have changed my whole life when I was younger.” What are those options? People think that they have exited their business. They're either going to shut the doors and sell all the assets, which is an option. Usually, not the best option. All the employees have to go away then and find new jobs. You're not going to get the highest dollar for your business in most cases. 

It is an option, or they're going to sell it to a buyer, probably a competitor, another option. Sometimes that is the best option, selling to a competitor or somebody up or down the vertical value stream. That's an option, but there are other options, too. You could do an internal transition. There still are, believe it or not, business owners who pass the business onto their children. It does happen. It's becoming increasingly rare, but legacy businesses still exist.

You want to be able to do that in a way that's equitable for you and your family member. You could transition to the management team. Maybe you have a great management team that is young, enthusiastic and has a vision for taking the business forward. You could do that. There's this program that I'm in love with. It's called the Employee Stock Ownership Program or ESOP. 

The reason that I'm in love with it is it's the best of a lot of different worlds. It's a federally qualified retirement program, which means that there's a trust that's set up that buys the business. It allocates stock from that business to the employees. The employees become owners, but they don't have the tax, the event that giving employees stock options brings up.

The Employee Stock Ownership Program is a federally qualified retirement program. There's a trust that's set up and it buys the business. It also allocates stock from that business to the employees.

The ESOP has a clause in it that trust to buy the shares back as people exit the business. There's liquidity in that stock. The business gets a tax break for being owned by an ESOP trust. The employee never has a taxable event until they use the money. Everybody wins from a tax perspective in an ESOP. That's a neat, relatively new, but gaining traction vehicle to exit a business with an internal transaction, where your staff ends up taking over the business. 

There are external transactions that are finding the strategic buyer, somebody up or down the vertical chain or a direct competitor. They can see the value by cutting out your SG&A. Maybe you have some secret sauce. I'm working with a company right now that is a wholesaler. They've got extraordinary purchasing power. They're a 30% better margin than the industry peers.

One of their competitors is likely going to want to buy them, wipe out all the SG&A and the bottom-line thing, but take that margin, that buying power and talk it into their business as a way to grow the bottom line without necessarily having a huge impact in revenue growth. There's that. There's private equity. Private equity has, in many circles, a bad reputation, especially after the ‘80s, when private equity was all about hacking and slashing staff. 

I'm excited to say that now labor is at such a premium that there are more private equity firms buying for staff than buying for the business. We turned around in that way. There are some good players in private equity. There are also some shady players in private equity. It could be a great option, but it's not always. You've got the IPO going public, as some people call it. That gives everybody a bunch of liquidity. It is a deeply arduous process, a ton of paperwork, a ton of compliance, and a ton of reporting. If you are in that billion-dollar range, this might make sense, but for smaller companies, it's usually not an option because the cost and the resource allocation to go public drowns out all the value that could be derived from it. 

If I can add one other thing about IPO, I've seen companies opt to do an IPO. In the process of becoming publicly owned, the culture, values, and mission that catapulted the business into profitable success get undermined by the shareholders in a publicly owned company, who are generally primarily motivated by increase in profits and ignoring the other factors. They're willing to sacrifice the other things that made the company succeed. I've seen some companies opt for IPO that because of their mission and their values would have been better served by remaining privately held. 

That's a big point. You have to realize that in any of these external transactions, the business is getting a new master. When you think about the internal culture and the vision and what it's going to take to drive the business forward, does it align with the motivations of the new master? You're exactly right. The IPO is the trickiest on that because shareholders want dividends. They want dividends and they want to increase stock in stock price. That's all they care about. That's a hard balance for a lot of businesses to negotiate. 

Thank you for bringing that up. That's a huge point. Frequently in what we call lifestyle businesses, sometimes, a high net worth individual, typically a corporate executive wants to get out of the corporate world. They want to quit answering to the shareholders and run a business again. You'll have some high-net-worth operators that want to buy a job.

Sometimes that's a great external exit. If you're thinking you've got even more runway and you want to put yourself in a new plateau of growth or of operation before you exit your business, you want to grow the business first, there are some M&A transaction options that can help you out there, too. There's what's called a recapitalization where you sell a minority stake of a going concern to get more capital in to grow. 

You could bring on new business partners. Similar to a recapitalization, usually a smaller scale, but in when you bring in new business partners, hopefully, they have some cash, but also some skills and expertise that will drive the business forward. Silent partners or equity investors, this is usually an early-stage play. You hear about venture capital or, as some of us in the business like to call them, vulture capital. You're going to give up a lot of your business frequently.

When you bring in new business partners, hopefully they have some cash, but also some skills and expertise that will drive the business forward.

When you're talking to equity investors, you're going to give up a lot of equity for the cash that you need, but they're also going to be pressuring you to give them liquidity in a certain time horizon. Sometimes it makes great sense. If you have a new product that is going to blow up and you have a buyer for your product once it's proven, getting an equity investor to help you launch the product in a big way, make that splash, and get the attention of the bigger player that you want to sell to, that could be a great play, but it's not always the play.

I wanted to highlight all of the different options because there are a lot of options. The earlier you start thinking about this and talking about it, the more time you give yourself, your team, and your family to think through and explore these options so that you can know when you go out to market. These are the 2 or 3 that make sense to us. This is what we'd like our advisory team to pursue in the exit. 

With that, we want to leave you with three takeaways from this episode for you to ponder and take action, to build out and to get whatever assistance you might need in order to implement these takeaways. The first of those is to identify your personal purpose. Stephen Covey, one of his principles in The 7 Habits of Highly Effective People was to begin with the end in mind. I would say it differently, begin with the best possible end in mind. The best possible end for an owner of a lower middle market business is to have a sense of what their impact mission is in the world.

What kind of positive impact do they want to have over and above their business, including their business, but not limited to their business? What is the ideal calendar, lifestyle, and legacy that they want to enjoy? What are their life balance commitments between now and when they're living their ideal lifestyle, calendar, and legacy? Identify your personal purpose because this is the secret to you giving yourself internal permission to have a life beyond your business so that you can do whatever version of exit is right match for you.

The second takeaway is to identify family and employee needs and do that proactively so that you can build what needs to be built prior to initiating or starting enacting your succession plan or your exit plan or whatever version of exit you're going to be implementing. Start talking with your family and with your team and with your partners about what a plan for the businesses next chapter beyond your ownership could look like that would address their concerns as well. Those are the first two episode takeaways. Jason, you're going to offer the third takeaway. 

I'm going to hit it right out of the park with us. I liked that, start talking with your family and team piece. One of the things that undermines a business during a transition like this is fear of the unknown and people knowing that something's up but not knowing what that something is and making their own assumptions. I love that you bring out that talking about this to the team early and often so that there isn't that fear and unknown.

Everybody's comfortable. “This is the next step. We're going to start the transition plan.” That's where I get to the last takeaway is start building out that transition plan. Just like any other good plan that you ever implement in a business, start with information gathering, then you bring the team and the resources together. That team finishes out the information gathering process and the planning process before any implementation starts to take place.

It's the same with this, know your options for an exit, but also know who you need around you to help make that exit as powerful as possible, like Dr. Gruder said, best possible outcome. Those are the big takeaways that we wanted to have you get from this show. We hope you enjoyed it. On behalf of David and myself, we thank you for reading. It's been a lot of fun talking about this. We hope that you've enjoyed it as well.

Know your options for an exit, but also know who you need around you to help make that exit as powerful as possible.

We look forward to reading your thoughts and comments in the comment section. We do take that seriously. It will drive our conversations in the next subsequent episodes forward. Please, feel free to do that. We'd also love to have you click the subscribe button so that you're notified immediately every time we have a new episode. We look forward to talking to you again in future episodes.

Important Links

• The 7 Habits of Highly Effective People