SELLING YOUR BUSINESS - EXIT STRATEGIES What is an exit strategy? Strategy is defined as the art or science of planning and the conduct of war. In business it translates as a long-term plan for success. You invested your time and money over, most probably, a number of years but how do you get your money out of the business? Who needs one? Every business owner should have at least one business exit strategy. One may not be sufficient because if circumstances change you should be prepared to change your mind and adapt accordingly. Even for those who have not yet, or only just, set up in business then the time to plan for the exit is now. Recently there have been instances where banks have refused to lend to businesses not because the business wasn t profitable but because an exit strategy did not exist. Banks justified their positions by stating that they wanted to determine when and how they would get back their money rather than having it tied up in a business on a permanent basis. Another aspect often overlooked by entrepreneurs is that of minimizing their overall tax payments from the business. With an exit strategy the business owners can make a decision as to whether it is better to withdraw as much cash as possible by way of salary, expenses or dividend against an alternative strategy of reinvesting as much as reasonably possible back into the business. With the latter strategy there may be capital tax reliefs available to the entrepreneur on the sale of the business but that is jam tomorrow rather than jam today which may not suit all. An example of tax relief on selling a business is the HM Revenue & Customs scheme known as Entrepreneurs Relief. Where a business and its ownership qualifies for the tax relief the entrepreneur can pay capital gains tax at 10% on the first 10 million gained on the asset sale and which is liable for Capital Gains Tax, CGT (in fiscal year April 2012 - April 2013). What exit strategies are there? In its most simple form the exit strategy can be when you have decided to call it quits then sell-off the individual assets of the business, pay-off your creditors and the cash that remains, after tax, is yours to keep. A variant of that theme is to maximize your takings from the business through income and run the business into the ground. Rather than reinvesting in the future of the business the owners calculate when they wish to exit and ensure the business has no further value on that date by asset stripping the business to that effect.
On rare occasions there are people who are business owners but who do not want to maximize their financial return from the sale of the firm. An example of one of these could be a certain type of environmental business where the underlying ethic is more important than the financial return. These social entrepreneurs are determined to see their ideas live on. Their reward stems not from the financial return but from the compensation of having achieved something tangible for the greater good and a legacy to be bequeathed by the like-minded. However, if the common maxim for business is adhered to then the desired outcome is to get the greatest return at a previously determined moment. For that the business owners will need to decide to whom they wish to sell the business. The ideal way to maximize value is through an arm s length agreement in an open market sale. If the business is quoted on a public stock trading market then that is fairly straightforward. Much more likely is that the business is in private hands and there will be restrictions on advertising for investors to take a share in the company or when the owners are selling only a minor, noncontrolling stake in the business. One way around this is to prepare the business to become a public company quoted on such a stock exchange. A word of caution here: such a course of action can be very costly so the company needs to be of a considerable size with several years of proven earnings or, alternatively, could be a relatively newly established business in a fast growth market e.g. IT or social communications. Taking such a route as part of an exit strategy is known as an IPO. That is an initial public offering where outsiders can purchase a shareholding in the company and can then trade these shares in the designated stock market free of interference from the company. At the IPO the company will receive the monies paid by the investors for the shares issued less costs. However the company is not under an obligation to return the funds to the shareholders unless under exceptional circumstances such as a share buyback. For a business to consider going public is a complex subject which requires specialist knowledge. More traditional routes include that of internal succession. Some entrepreneurs decide that they will pass on the business as an inheritance to family members who might already have a grounding in the family business. As well as the pragmatic side of matters there is often an element of vanity here in starting or building a dynasty. That must be considered if wealth maximization is the intent. A variation of this theme is where there is a management and employee buy-out of the business. Employees will have a good understanding of the firm and the industry in which it operates and will be keen to apply their knowledge and experience to maximizing future gains for themselves.
Where an entrepreneur decides to sell either all or the majority of the business then the ideal marketing solution is to appoint an agent. Trade newspapers and magazines are an obviously well used route but usually means the market for a potential buyer is restricted to competitors, suppliers or others within the industry. The use of a marketing agent ensures that many more potential buyers become aware of the opportunity. Prospective buyers can stem from related industries, completely unrelated industries but where the buyer wants to diversify, or from different geographical areas with which the seller has had no connection but the buyer is looking to expand into the geographical area in which the seller operates. To maximize returns a marketing plan will need to be adopted and that forms a separate paper in this series. When planning the exit strategy it should be borne in mind that on many occasions the business purchaser will want the previous owner i.e. you, to remain with the business for a specified period of time. That may not be in a public role but possibly behind the scenes to advise on customers, suppliers and processes. So if you are looking at some of the above strategies do not plan to spend the next 12 months sunning yourself on a Caribbean island as you may be in for a rude awakening. You may even find that the prospective purchaser requires you to take a more active major role to demonstrate your faith in the business whilst they learn the ropes of the industry. That occurs more usually when the purchaser is a new entrant to that particular industry or geographical market. It then becomes what is known as an earn-out where you, the business seller, is paid a retaining salary and the transfer of the business is gradual and whereby the business selling price is paid partly out of future earnings. When the business is bought-out in staged payments a point that is often overlooked by the seller is that capital gains taxes may fall due on the first instalment of the transfer. In some rare occasions the seller may find they owe more to the tax authorities than they receive in their first receipt paid by the buyer. In a worst case scenario you might find capital gains tax has been paid on the first instalment leaving you out of pocket and the business you sold then defaults on future payments. There are insurance schemes available against such default but they tend to be complex and costly.
Whichever of these strategies you consider - and you should consider more than one - it is strongly suggested that advance advice and advance approval where possible is gained from not only the tax authorities but any specialist trade or licensing authorities whose agreement will be required. Do not forget to include your landlord in the discussions as most leases will have a clause giving the landlord a right to refuse transfer of the premises to a new tenant if the prospective tenant cannot prove they can meet certain criteria demanded by the landlord and / or property owner if that is a different person. How will we help you? To help you decide which exit strategies are most appropriate for you - and remember always consider more than one - we will discuss with you what your plans are, when you wish to exit the business and how the business is likely to perform until such time as you decide to move on. A more general picture of the industry as a whole is instructive. Is the industry expanding or just ticking over? Is there consolidation with stronger rivals buying out the weaker? If so, is that because there is too much competition, business inefficiencies, regulation or some other reason? Do not forget that the business should be in good financial health at the time it is put up for sale so as to maximize the selling price. If a prospective buyer takes the view that you as the owner has neglected the business prior to sale then they will negotiate down the price you could have achieved. We will help you. We will assist you in dealing with the various licensing and regulatory authorities as well as communicating with HMRC to ensure they can give advance approval, insofar as they can, for your exit strategy when it does happen with a view to minimizing your tax bill. The current UK Government has stated its intention to crack down not only on tax evasion schemes (which are illegal) but on tax avoidance schemes (which currently are legal). HMRC has been asked to consider general tax avoidance enforcement so HMRC advance approval is recommended in all cases where there could be a potential tax liability to the seller. We can help to ensure compliance with the laws and regulations in force at that particular time. An exit strategy does not stand on its own and must be interwoven with all other parts of the processes in this series on Selling Your Business. We are here to ensure you maximize your profit from your sale and to minimize the stress during all the steps involved. A seamless transition benefits all parties involved.
If you have any queries arising from this paper or would like to discuss any other matter, please do not hesitate to contact Calum I Duncan or his colleagues. Calum I Duncan Corporate Lawyers Ltd Inverness www.duncancorp.com For further information or advice feel free to contact us on 01463 211160 or by e-mail at calum@duncancorp.com Disclaimer The information contained in this paper is general in nature and is not intended to have specific applicability. You should seek your own professional advice on the matters addressed based on your own particular circumstances. Consequently, no liability shall be accepted by us in respect of the content of this paper.