Five Exit Strategies Ever think ahead to the day when you'll no longer run your biz? These strategies will help you prepare for your future.
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Entrepreneurs live for the struggle of launching theirbusinesses. But one thing they often forget is that decisions madeon day one can have huge implications down the road. You see,it's not enough to build a business worth a fortune; you haveto make sure you have an exit strategy, a way to get the money backout.
For those of you who like to plan ahead--and for those of youwho don't but should--here are the five primary exit strategiesavailable to most entrepreneurs:
The Modified Nike Maneuver: Just Take It. One favoriteexit strategy of some forward-thinking business owners is simply tobleed the company dry on a daily basis. I don't mean run it inthe red--I mean pay yourself a huge salary, reward yourself with agigantic bonus regardless of actual company performance, and issuea special class of shares that only you own that gives you tentimes the dividends the other shareholders receive. Although wefrown upon these practices in public companies, in privatecompanies, this actually isn't such a bad idea. It's calleda "lifestyle company."
Rather than reinvesting money in growing your business, inlifestyle companies, you keep things small, take out a comfortablechunk, and simply live on the income. In one of my most memorableHarvard Business School moments, my fellow classmates and I askedthe owner of a small, fabulously profitable manufacturing companywhy he didn't grow the business bigger and sell it for agazillion dollars. His response: "Excuse me? You've hadway too much schooling. What part of 30-hour work weeks and a $5million personal income don't you understand?"
Remember, money in the wallet is no longer money in thebusiness. If you're in a business that must invest to grow,taking out too much money can hurt you down the road. Also, if youhave other investors, taking too much can upset them. Imagine theirsurprise when investors in a small business I once worked forreceived the company's internal loan repayment spreadsheet,showing that the business owner was pulling out bucks by paying hisfamily exorbitant interest on loans while investor loans wererepaid at rock-bottom rates over as long a time period aspossible.
If you think you're in business for the lifestyle, minimizeyour dependence on other investors and structure the business toallow you to draw out cash as needed.
- Who doesn't like seven figures of take-home pay?
- Private jets are fun.
- There's no need to think hard about getting out: Just pullout the money when you need it.
- The way you pull the money out may have negative taximplications. For example, a high salary is taxed as ordinaryincome, while an acquisition could bring money in the form ofcapital gains.
- Without careful long-term planning, you may end up pulling outmoney now you'll need later.
The Liquidation. Even lifestyle entrepreneurs can decidethat enough is enough. One often-overlooked exit strategy is simplyto call it quits, close the business doors, and call it a day. Idon't know anyone who's founded a business planning toliquidate it someday, but it happens all the time. If youliquidate, however, any proceeds from the assets must be used torepay creditors. The remainder gets divided among theshareholders--if there are other shareholders, you want to makesure they get their due.
- It's easy and it's natural. Everything comes to anend.
- There's no negotiations involved.
- There's no worrying about transfer of control.
- Get real; it's a waste! At most, you get the market valueof your company's assets.
- Things like client lists, your reputation, and your businessrelationships may be very valuable, and liquidation just destroysthem without an opportunity to recover their value.
- Other shareholders may be less than thrilled at how muchyou're leaving on the table.
My favorite piano bar in Boston simply vanished one day when theowner decided he was tired of show tunes. His regular patrons werecrushed, but then, he didn't consult with us first....
Selling to a Friendly Buyer. If my neighborhood piano barowner had asked, we might have wanted to buy the businessourselves. You see, if you've become emotionally attached towhat you've built, even easier than liquidating your businessis the option of passing ownership to another true believer whowill preserve your legacy. Interested parties might includecustomers, employees, children or other family members.
The fictional Willy Wonka handed off his chocolate empire to alittle boy who was a loyal Wonka customer, someone who was chosenwith great care through a selection process designed to weed outall but the most dedicated Wonka devotees. Wonka was able to choosehis heir apparent and ride off into the sunset a happierentrepreneur.
Of course, the buyer needn't come from outside. You can alsosell your business to current employees or managers. Often in thiskind of sale, the seller finances the sale and lets the buyer payit off over time. A hair stylist I knew learned a local salon ownerwas shutting his doors and decided to propose a low-money-down dealto acquire the salon. The owner still makes more this way than hewould by closing, and the stylist gets to earn his way into owninga business. It's a win-win for everyone involved.
The purest friendly buyout occurs when the business is passeddown to the family. But remember, the key to "familybusiness" is the word "family." Is yours functional?No sooner than you leave the family business to the kids, it'slikely they'll end up fighting over who got the larger share,who does or doesn't deserve the ownership they got, and whogets the final word. They'll finger-point for a decade whilethe business slowly declines into ruin, then blame you for notleaving clearer instructions. If you decide to go this route,you've got a lot of planning to do before getting out.
- You know them. They know you. There's less due diligencerequired.
- Your buyer will most likely preserve what's important toyou about the business.
- If management buys the business, they have a commitment tomaking it work.
- Selling to family makes good on that regrettable offhandpromise made 30 years ago, "Someday, son/daughter, all thiswill be yours."
- You can get so attached to being bought by someone nice thatyou leave too much money on the table.
- If you sell to a friend, they'll be peeved when theydiscover they just bought the liability for that decade's worthof taxes you forgot to pay.
- Selling to family can tear the company apart with jealousiesand promotions that put emotion way ahead of business needs.
The Acquisition. The acquisition was invented so you cansell your business and leave the kids money, still spoiling themrotten, but at least sparing the business from second-generationruin. Acquisition is one of the most common exit strategies: Youfind another business that wants to buy yours and sell, sell,sell.
In an acquisition, you negotiate price. This is good. Publicmarkets value you relative to your industry. Who wants that? In anacquisition, the sky's the limit on your perceived value. Yousee, the person making the acquisition decision is rarely the ownerof the acquiring company, so they don't feel the pain ofacquisition cost. Convince them you're worth a billion dollars,and they'll gladly break out their employer'scheckbook.
If you choose the right acquirer, your value can far exceed whatwould be reasonable based on your income. How do you select theright company? Look for strategic fit: Which acquirer can buy youto expand into a new market, or offer a new product to theirexisting customers? I recently read that a classmate of minestarted a company that was acquired during the Internet boom for$500 million when it was just 18 months old. He commanded a hugeprice because his acquirer thought the acquisition gave themcritical capabilities faster than they could develop thosecapabilities on their own.
But acquisition has its dark side. If there's a bad fitbetween the acquirer and acquiree, the combined companies canself-destruct. The acquired management team can end up locked intoworking for the combined company, and if things head south, theyget to watch their baby implode from within. Time Warner recentlyannounced that they're thinking of spinning off AOL, almostexactly five years after the two companies merged. What, exactly,did the merger accomplish? It made two CEOs very wealthy--anddestroyed years' worth of work and billions of dollars. I'msure the AOL employees who stuck it out enjoyed that particularride!
If you're thinking of acquisition as your exist strategy,make yourself attractive to acquisition candidates, but don'tgo so far as to you cut off your other options. One softwarecompany knew exactly whom they wanted to sell to, so they developedtheir product in a way that meshed perfectly with the prospectivesuitor's products. Too bad the suitor had no interest in theacquisition. The software company was left with a product sospecialized that no one else wanted to buy them either.
- If you have strategic value to an acquirer, they may pay farmore than you're worth to anyone else.
- If you get multiple acquirers involved in a bidding war, youcan ratchet your price to the stratosphere.
- If you organize your company around a specific be-acquiredtarget, that may prevent you from becoming attractive to otheracquirers.
- Acquisitions are messy and often difficult when cultures andsystems clash in the merged company.
- Acquisitions can come with noncompete agreements and otherstrings that can make you rich, but make your life unpleasant for atime.
The IPO. I've saved IPOs for last, becausethey're sexy, they're flashy, and they get all the press.Too bad they make the lottery look good by comparison. There aremillions of companies in the U.S., and only about 7,000 of thoseare public. And many public companies weren't even founded byentrepreneurs but rather were spun out from existing companies.Heck, AT&T and its spin-offs are almost a significant fractionof the listed exchanges!
If you're funded by professional investors with a trackrecord of taking companies public, you might be able to do it. Ofcourse, the professional investors will also have diluted you downto the point where you only own a tiny fraction of your companyanyway. The investors will make out great. And maybe, if you'rethe principle entrepreneur and have done a great job protectingyour equity, you'll make some money, too.
But if you're a bootstrapper, believing in a fair IPO is atouchingly naïve act of faith. Besides, do you have any ideawhat's actually involved in an IPO?
You start by spending millions just preparing for the road show,where you grovel to convince investors your stock should be worthas much as possible. (You even do a "reverse split," ifnecessary, to drive up the share price.) Unlike an acquisition,where you craft a good fit with a single suitor, here you romancinghundreds of Wall Street analysts. If the romance fails, you'veblown millions. And if you succeed, you end up married to analysts.You call that a life?
Once public, you bow and scrape to the analysts. These earnest28-year-olds--who haven't produced anything of value sincewinning their fifth grade limerick contest--will study your everymove, soberly declaring your utter incompetence at running thebusiness you've built over decades. It's one thing toreceive this treatment from your loving spouse. It's quiteanother to receive it from Smith Barney.
We won't even talk about the need to conform toSarbanes-Oxley, or the 6 percent underwriting fees you'll payto investment bankers, or lockout periods, or how down markets cantank your wealth despite having a healthy business, or howIPO-raised funds distort your income statement, or ...
In short, IPOs are not only rare, they're a pain in thebackside. They make the headlines in the very, very rare cases thatthey produce 20-year-old billionaires. But when you're foundingyour company, consider them just one of many exit strategies.Realize that there are a lot of ways to skin a cat, and just asmany ways to get value out of your company. Think ahead, surely,but do it with sanity and gravitas. And if you find yourselftempted to start looking for more office space in preparation foryour IPO in 18 months, call me first. I'll talk you down untilthe paramedics arrive.
- You'll be on the cover of Newsweek.
- Your stock will be worth in the tens--or maybe evenhundreds--of millions of dollars.
- Your VCs will finally stop bugging you as they frantically tryto insure their shares will retain value even when the lockoutperiod expires (Warning: they won't necessarily be looking outfor your shares, too.)
- Only a very few number of small businesses actually have thisoption available to them since there are very few IPOs completedannually in the United States.
- You need financial and accounting rigor from day one far abovewhat many entrepreneurs generally put in place.
- Some forms of corporation--S-corps, for example--will require areorganization before they can be taken public.
- You'll spend your time selling the company, not runningit.
- Investment bankers take 6 percent off the top, and thetransaction costs on an IPO can run in the millions.
- When your lockout restrictions expire, your stock will be worthas much as a third world hovel.
Stever Robbins is a veteran of nine startups over 25 yearsand is the author It Takes a Lot More than Attitude to Lead aStellar Organization. He co-designed the "Foundations"segment of Harvard's MBA program and has has appeared on CNN-fnand in the Wall Street Journal, Investors Business Dailyand Harvard Business Review. Stever and his monthlynewsletter can be found at http://SteverRobbins.com.