MBA management

Exit a Business Topics:

Introduction


An entrepreneur starts a business with a positive mindset, wishing to establish and grow the company .The main goal is profit maximization. However, it is also prudent to plan for one’s exit from the firm. Sometimes, it is wise to think of your exit strategy while setting up the business itself.

An exit strategy can be termed as the planning behind terminating one’s ownership of a company. Very few entrepreneurs seriously think about an exit strategy.

Reasons for Exiting


There are several reasons for an entrepreneur who wants to exit his venture. Some of the more common reasons are analyzed below:

1) Lack of Profits: If the business ceases to be profitable, then the entrepreneur has no motivation for continuing with it unless he/she sees profits coming at a later time. If the entrepreneur thinks that the business can be sold, he/she would rather get out of a business that is not profitable and start something else that is more remunerative.

2) Loss of Interest: A business may continue to be profitable but may not be of interest to the entrepreneur any longer. This may be because the entrepreneur was interested in starting the business bur has no great interest in managing mundane day-to day operations.

3) Future Prospects: The business may be doing well in the short run, but the entrepreneur is not sure of its long-term sustainability.

4) Dissolved Partnership: If a venture starts as a partnership from which subsequently one partner opts out, usually, the other partners steep in and buy his/her share. Sometimes, that is not enough.

5) Disinclined to take Further Risks: Sometimes, the entrepreneur exits because he/she is not inclined to take those risks. If there are significant growth possibilities for the business, it is attractive to buyers. The entrepreneur can comfortably make a profitable exit.

6) Other Opportunities: The entrepreneur started this business because it seemed the most exciting and viable opportunity at that time. Latter, other opportunities would come up that would seem to be even more exciting. If any single opportunity proves to be irresistible, the entrepreneur will want to exit the current venture and try a new business.

7) Personal Reasons: entrepreneurs may leave a promising venture due to personal reasons. Unexpected illness, death in the family, divorce, etc. are reasons that might prompt entrepreneurs to leave a thriving business. These are the reasons that become more important than profit maximization and success of the venture.

8) Favorable Economic Conditions: If the times are good and the economy is looking up, it might be a good time to exit the business, the logic is- good times are not going to last forever, so get out when the going is good. There can be facilitating circumstances such as low- interest rates for the buyers to access money to buy.

Options for Exiting a Business


Choosing the optimum exit option for the business is a vital part of exit strategy planning. There are at least eight main ways in which can be used in disposing of business. There are also various variations on the main ways. One example of a variation is where in a trade sale businessmen sell part only of the shares rather than all of them. Another is where in a management buyout an outside Chief Executive Officer (CEO) is brought in to assist the internal management, making it partly a buyout and party a buy-in.

The main exit options available to a private business are as follows:

1) Family Succession
2) Franchising
3) Sole Trader Mergers
4) Selling a Business
5) Ceasing to trade/Close Down

Family Succession
A family succession involves passing on your business to a family member, such as a child. Most private business owners with children, or who have a close relationship with a younger relative, usually are favorably inclined to this exit choice where it is practicable.

Unfortunately, even those with close relatives such as children, often find that their heirs are not interested in, or capable of, taking over the running of those without a family heir, the family succession option is family business. For these people and for those without a family heir, the family succession option is, obviously, not applicable.

Although desirable from the point of view of personal satisfaction for the owner, family succession can be the most difficult exit strategy of all. The greatest problems are that family and business goals and cultures often clash, objectivity is often absent and emotion rather than business practically takes over.

Franchising
Like a flotation, franchise business could be a multi- staged exit strategy. The first stage would be to establish a franchise business by selling- off part of the current business operations. Next businessmen could sell further franchise outlets and eventually he could dispose of the franchisor business itself.

If businessmen are thinking about franchising the business as an exit option, he should check initially whether the business might be suitable. The following characteristics are usually necessary for a business to be successfully franchised:

1) It must have a strong brand recognition, or be able to build one.

2) It must a unique or new way of conducting business (i.e, a unique operating system), or an aspect of its business that is unique, such as a formula.

3) The business system must be relatively simple and be able to be taught to others, so that suitable franchisees can be found.

4) It must be able to duplicate its operations outside its current geographical areas of operations.

5) There must be sufficient gross margin in the business for the franchise to pay the franchise fees and still make a reasonable net profit.

6) The business must have financial and operational systems in place that can keep track of the franchisees operations and ensure that the franchisor gets paid.

Sole Trader Mergers
A merger is when two companies get together, establish a value on each company and then combine the two to from one bigger company. In most mergers, the company shareholders receive stock in the bigger company which is presumably worth more than the stock held in each independent company. Therefore, be aware that in mergers, you may not actually receive cash for some time.

The mergers we are considering here are those between smaller private business and professional practices who are, typically, sole traders. This exit option allows a retiring business owner to plan an exit strategy at an early stage through an arrangement with another owner, who is keen to expand his business. For the retiring owner this can be a relatively low-risk option and allows some latitude in working-out your retirement at a reduced level of intensity in the newly merged business.

The sole trader merger can be a three-staged exit strategy:

Stage 1 involves the merger of two businesses (with perhaps an initial purchase of equity).

Stage 2 involves the buy-out of the older owner’s interest (or the balance of his interests) in the merged business by the younger owner.

Stage 3 could involve the retiring owner working – out a retirement period as an employee.

To consider exiting through this method be, typically, a sole trader and you would need to find a younger sole trader in the same industry with a similar working philosophy as yourself.

Selling a Business
The owners of a troubled business will often choose to sell it to another company that can take advantage of the troubled company’s assets, particularly such intangibles as its customer base and goodwill. Such a sale may provide you more in return for your past sweat equity than a simple close-down. Key considerations in such a sale are the nature of the payment (Cash or stock in the acquiring company), the timing of the payment (immediate or deferred), and any contingencies associated with the payment of the purchase price.

The type of payment is extremely important in determining whether sale is preferable to close-down. Cash obviously lets you exit cleanly, but it may subject the transaction to taxes. By accepting stock, you retain some residual risk depending on the strength of the company purchasing the business, the nature of the stock (Public versus private company), and the valuation put on the stock versus the purchased business. The payment’s timing is also critical. The payment deferred may be payment denied if the purchasing business itself fails later.

If a sale is undertaken as a way to close the business, the sale will involve the same considerations as those in the sale of a successful business.

Options for selling a Business
1) Management ( and/or Employee) Buy- outs( MBO): MBO is the purchase of a business by its management when the existing owners are trying to sell business to third parties due to its slow growth or lack of managerial skills in running the business. The existing managers will come forward to purchase and run the business by owners. The management team will substantial controlling interest all or part of the business from its owners. The management team will take substantial controlling interest from the existing owners who are having control over the affairs of the company. The management team may consist of one or more directors and employees, either with or without inviting for external associates.

It is a divestment technique to sell the business which does not fit in with the new strategic plan of the group. The management will know the strengths and weakness of the business they are proposing to purchase from owners and can make a better bargain.

Contrary to common belief, exit through an MBO is available to any private business and not just the larger ones; nor are Venture Capitalists (VCs), or corporate finance specialists, or bankers necessary to organize them. An MBO is simply a business sale where thee buyers are the management and/or employees of the business. It is true, of course, that financiers do get involved in most MBO by arranging the financing and taking an equity stake in the business, but this is not a prerequisite for an MBO.

An MBO is also a widely used exit strategy by public companies wishing to disperse of subsidiaries that are considered not to do core group operations.

MBO Requirements

There are two aspects that need to be present, namely:
i) Cash flow: Employed managers are not usually wealthy and, consequently, they will need to borrow a large portion of the purchase price if they are to undertake a successful buy-out. This will result in a substantial interest bill and the business will, of course, have other needs for cash, not least being reasonable salaries for the managers themselves. If the managers are put under too much financial pressure the business itself could be in danger of collapse. If you as vendor are part of the financing arrangements through proving vendor finance, this will, of course, put your own position in danger also.

ii) Management Expertise: It is usual for an MBO to be a team effort, with line managers, a CEO and financiers making – up the team. At the head of the team should be an effective experienced CEO who has the right leadership qualities and good relations with the rest of the team. The management team should include members who have a wide range of business skills. Where the MBO is being financed from outside, the managers must have the confidence of the financiers and the ability to ‘talk their language.’

Generally speaking the management should have the following attributes:
i) Experience in the essential operational functions of the business;
ii) Strong financial management skills;
iii) Involvement in the day-to-day running of the business in a hands-on way;

The ability to produce well thought out strategic and business plans, with accurate financial forecasts.

2) Management Buy-Ins (MBI): An MBI is an MBO in which outside management (Usually an individual with particular talents) puts a team together to purchase a business from a private business owner or a public company. Where an individual is brought in by the financiers to bolster a management team that has perceived management weaknesses, this is a hybrid transaction called a MBI/MBO or ‘BIMBO’. A further variation on this is where an institution initiate and drives-out (called an ‘IBO’).

As a business owner if businessmen feel that his business is suitable for a management buy-out but that there are weaknesses in the current management team, he could try to find a suitable outside party as the potential CEO to lead a buy-out team. On the other hand, potential CEOs from outside thee business could recognize an opportunity in his business and they initiate a buy-in.

3) Public Listing/ Flotation: Floating the business is selling the business in stock market. Most private businesses do not make enough profit (nor have the profit potential) and are not big enough in terms of capital to be attractive to investors, or to qualify for the minimum requirements of either the London Stock Exchange’s ( LSE) Main or Alternative boards. But although this appears to rule-out the listing option for most private companies, the rules are not hard and fast.

In certain phases of the economic cycle investor requirements are more biased towards entrepreneurial enterprises and profit potential could be enough to attract investor support for a floatation. Also the LSE rules for the Alternative Investment Market (AIM) are not as strict as for the main board and alternative opportunities with less structured rules, such as OFEX, exist for smaller companies.

A flotation of the company is best considered as a multi- staged exit strategy, that is, an initial sale of the equity to the public followed by the opportunity to sell further trenches of equity into a much more liquid market and at, hopefully, ever- increasing prices. A floatation can be a high reward strategy and if you have a profitable business with strong growth potential you should give serious consideration.

4) Employee Stock Ownership Plan (ESOP): An alternative to selling the company to outside investors or to another company is to sell the company to its employees. This can be done through the creation of an employ Stock Ownership Plan (ESOP) and the sale of the corporate finance purposes with tax advantages. ESOPs are a special feature of the Federal Tax Code, designed to give companies tax benefits for providing employees significant ownership of their employer. Under the federal Tax Code, company contributions to an ESOP are tax deductible as a form of employee benefit. Participants avoid taxation on their interest in the ESOP until after their retirement. As with all retirement plans, SOPs have to quality under section 01(a) for employer contributions to be tax deductible. There are also the customary complicated employee- benefit regulations that must be satisfied.

The vast majority of EDOPS are created by closely held companies, although many large public companies also have established them. One reason closely held companies use RSOPS is that their shareholders can sell shares tax-free to an ESOP if certain tests are met. This sale avoids, at least temporarily; recognition of the gain for tax purposes. To gain this tax advantage, the proceeds of the sale must be re-invested within 12 months after the sale to the SOH in the securities of domestic operating corporations. The selling shareholders must have held the stock for at least a three-year period before the sale. The ESOP must own at least 30 percent of the company after the transaction and, more specifically at least 30 per cent of the total common equity on a controlling- interest basis. Alternatively, immediately after the transaction, the ESOP must own at least 30 per cent of the total number of shares of each class of stock.

The three basic types of ESOPs are;
i) The leveraged ESOPs.
ii) The non-leveraged cash-warehousing ESOP, and
iii) Non-leveraged newly issued stock ESOP.

5) Trade Sales: A sale to a third party on the open market ( known as a trade sale) is the method of disposal most private business owners think of when they consider disposing of their businesses, and it is still the way most private businesses are sold. Most businesses in most industry sectors are suitable for a trade sale and there are usually no special attributes you or your business need if you are to dispose of it through this route.

6) Slump Sale: When a company sells or dispose the whole or substantially the whole of the undertaking for a pre- determined lump sum amount as sale consideration is called ‘slump sale’. The acquirer may be interested in purchase of an undertaking or part of it as a going concern and the acquirer may be interested thee whole company as part of the transaction. While fixing the selling price, the values of assets are not individually counted and the liabilities are not separately considered while fixing thee slump price, A business transfer agreement will be entered into between the acquirer and seller and the hive-off dal passes the title for both movable and immovable properties and the related liabilities as a ‘going concern’.

7) Sell-Off: In a strategic Planning process, a company can take decision to concentrate on core business activities by selling – off the non-core business divisions.

A sell-off is a sale of part of the organization to a third party in the following circumstances:

i) To come out of shortage of Cash and severe liquidity problems.
ii) To concentrate on core business activities.
iii) To protect the firm from takeover activities by selling-off the desirable division to the bidder.
iv) To improve the profitability of the firm by selling- off loss making divisions.
v) To increase the efficiency of men, machines and money.
vi) To facilitate the promising activities with enough funds by selling-off non performing assets.
vii) To reduce the business risk by selling- off the high risk activities.

8) Liquidation of Assets: A business may go into decline when losses are made over several years. The losses are set- off against profits retained in the business (reserves), but clearly the situation cannot continue for very long. In such case liquidation of company may be imminent. In case of technological obsolescence, lack of market for the company’s products, financial losses, cash shortages, lack shortages, lack of managerial skills, the owners may decide to liquidate the business to stop further aggravation of losses. With a strategic motive also, a business unit may be liquidated.

If you don’t have any debts, you can also achieve liquidity by shutting down your business and selling the assets that you have. Of course, you’ll need to find buyers who feel that your assets have value, and you’ll have to negotiate a fair price for those assets that are not clearly identified in terms of a price point. With this kind of exit strategy, you are usually getting the smallest amount of money because you’re just selling the raw assets and aligning your buyers with a price they are willing to pay.

If you want to sell your business for retirement funds in the future, take the time now to create an appropriate business exit strategy. Carefully structure your plan to see what liquidity is going to be for you. And down the road, you’ll find that you’ve built a business that has value on others without you having to be there every day to run it.

Ceasing to Trade/ Close Down
If ‘going concern’ status is not maintained, most businesses will lose a large part of their value. Experience shows that assets such as plant and equipment, or stock, which are sold in auctions ( or on fire sales) seldom fetch their so- called ‘market value’ and often sell for less than their written- down value. Even real property can fail to reach market value when there is a forced sale. Just as damaging will be the fact that a business, which is not a going concern, will usually have no goodwill value.

To close- down your business and attempt to sell- off its assets is, therefore, usually the worst of all exit options for you. However, there are circumstances where the value of the business as a going concern is no greater than the value of its assets and, indeed, when the value of the assets could exceed thee going concern business value. It is in these circumstances that an orderly disposal of a solvent company’s assets (followed by liquidation of the company) could make financial sense.

Sometimes thee close down of your business will be not of your choosing. If you are forced through insolvency to liquidate your company, then planning an exit is out of your hands.

Reasons for Closing a Business


1) Voluntary Dissolution: This is when you decide to close the business on your own.

2) Expiration of Existence: Some businesses have a specified term of existence in their articles of organization or incorporation. The business may file Articles of Amendment of extend its otherwise it will cease to exist.

3) Involuntary Dissolutions: If a corporation or limited liability company fails to file an Annual Report with the Secretary of State’s office by the specified deadline, the Secretary of State, after sending a reminder, may dissolve the business. If you want to be” reinstated” after thee being involuntarily dissolved, you must file an Application for Reinstatement within a certain timeframe of dissolution.
You may also be forced to file for bankruptcy due to inability to repay debts.

4) Suspensions: Corporations that fail to file tax returns with the department of Revenue for a specified number of years will be suspended or will forfeit their right to do business in the respective state. The corporation must pay its delinquent taxes within a certain timeframe of receiving a notice from the department of Revenue or it will be dissolved or revoked by the Secretary of State.

5) Special Circumstances: Some types of businesses may dissolve under special circumstances. For example, a limited liability company may dissolve if a member withdraws from the arrangement and the remaining members cannot agree on whether or not to continue being in business. Limited liability partnerships and limited partnerships will lose their liability protection unless they re-register every specified number of years.

Process of Closing a Business


Getting out of business is a process. The length of time required to complete the process is directly related to the complexity of the business and the circumstances underlying this decision to get out of business. It can range from one week for a home-based sole proprietorship to several years for a corporation forced into involuntary bankruptcy. Disputes and litigation add another dimension to the timeframe.

The process for exiting a business usually includes the following steps.

1) Reach Agreement and obtain Authorization from Owners to Dissolve our Business Entity: Agreement and authorization to dissolve a business must be established under some acceptable, governing set of rules, such as the bylaws or partnership agreement. It is best to settle dispute quickly and document any terms and conditions that apply.

2) Designate a Leader and Organize a Team: Authority and roles should be clarified. The owner may be the only team member for a home-based business. For a large entity, however, the team may consist of the executive management team and important functional managers whose expertise is not represented: finance, human resources, legal. This group should be as small as possible for efficiency and large enough to include the expertise required to cover the basic planning issues.

3) Engage Professionals and Consultants as Team Members: For most small businesses, this group consists of the firm’s legal counsel, CPA and a business broker or valuation expert. Professional expertise and advice in these areas will contribute to a smooth process and improve the outcome.

4) Perform a thorough Review of Business and Identify Problem Areas: Establish and maintain a problem list to focus on. Determine the condition of the firm’s records. Review transactions. Problems extend the timeframe and cost money.

5) Prepare a List of Assets and Perform a Physical Inventory: The inventory is very important input to several activities. It is used to establish the value of the business, make decisions and manage disposition of assets and it becomes the basis for tax calculations and tax returns.

6) Perform a valuation of the Business: It is difficult to make prudent decisions without knowing thee market value of the business and its assets.

7) Prepare a detailed plan and assign responsibilities.

8) Develop a schedule for Implementation: A Schedule provides the ability to measure progress, estimate completion of critical steps and project the end of the process. The schedule is also extremely useful for managing cash flow during this uncertain time.

9) Release Announcements and Notices: This step is about timing and legal notice. At some point, interested parties must what is happening: market, competitors, customers, vendors and suppliers, professional service providers, consultants, trade groups, employees, media, creditors, contractors. The notice should designate an official point of contract for questions or inquiries.

10) Implement the Plan: This is where momentum and activity builds. Things happen very quickly. Without the planning steps, an important degree of control is lost. When that happens , net value is usually decreased in some substantial way.

11) Conclude or Transfer Contract Obligations: This process may require approval from contracting parties, and involve negotiation of final terms. Office, car and equipment leases need to be reviewed, addresses, and terminated. The timing of termination dates for insurance contracts and benefit plans are very important to all those who involved.

12) Close Operations: The timing of this step is important. There is a time when manufacturing or production must cease, retail sales must end, and human resources are pared down. Each affects cash flow and net value dramatically. Security and maintenance services may be an important consideration from this point of view.

13) Dispose – off and Transfer Assets: This is an important tax event. Insurance coverage can be reduced or eliminated.

14) Settle accounts payable and debt obligations.

15. Prepare Final Financial Statements and Tax returns: Final financial statements for the business are important to establish the tax implications for assets, gains and losses conveyed to the owners, or other involved parties.

16) File Articles of Dissolution: State licensing departments require a formal filing to terminate the legal and tax status of the business. Examples are articles of dissolution, certificates of withdrawal and cancellation certificates. This process also results in a review of tax liabilities and issuance of a tax clearance notice or certificate.

17) Prepare and Issue Special Fillings, Notices, Informational Returns and Taxes: To develop a checklist, re-trace our steps taken during start-up. Generally, some action is required with all federal and stage registration, taxing and licensing agencies contacted to start the business. Final submittals of payroll, unemployment, industrial insurance and other business tax returns must indicate that the business status is closed or changed.

18) Receive Tax Clearance Notice: File in financial records.

19) Close bank account.

20) Store Business Records: These records should be kept for at least seven years.

Planning and awareness are crucial. The process, timing of event and tasks must be tailored to the type and complexity of the business. Each case is unique because reasons for dissolution differ, and problems that exist or develop are unique to the circumstances. Take a look at this checklist of items to consider as early in the process as possible. Most of these issues have some impact on the process of getting out of business.
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