Business owners: Gauging your exit readiness

Special to MassMutual

By Special to MassMutual

Posted on Sep 21, 2020

A planned exit from one’s business is usually an occasion for celebration. It’s often the culmination of years of hard work and a symbol of success. But for some business owners, the celebration ends too quickly. Chris Vanderzyden, a principal with Legacy Partners, LLP, has witnessed it herself.

“Seventy-five percent of owners regret their decision to leave within a year of selling,”1 she said. “The reasons vary, ranging from worrying that they made a bad deal or that they won’t have enough money to live on, to being unable to design a new life for themselves.” Clearly, for these individuals, things didn’t turn out as planned.

However, “planned” may be a misnomer. According to Vanderzyden, 83 percent of owners never get around to developing a written exit strategy.1 While most spend years or even decades building a business, they are too busy to plan when, why, and how they’ll exit the business.

“They should know their timeline, set goals, and have a plan and process in place,” Vanderzyden explained.

She believes it usually takes three to five years to position a business for transfer. The to-do list is a long one and covers five major areas:

  1. Make sure the business is a transferrable asset.
  2. Untangle personal finances from the business.
  3. Understand the value of the business.
  4. Identify and prepare the right successor.
  5. Determine your second act.

Here is a closer look at each of those elements.

1. Make sure the business is a transferrable asset

A business is a collection of intangible assets that make it valuable and transferable. Positioning the business requires demonstrating evidence of a well-diversified, growing customer base; dependable sources of recurring revenue; a capital structure that supports growth; quality management; and operational efficiency. There should be comprehensive documentation of all complex or proprietary processes, and the financials must be clear, with no co-mingling of personal and business funds.

2. Untangle personal finances from the business

Untangling serves a dual purpose. First, it makes good business sense for tax and accounting purposes and therefore makes the business more appealing to potential buyers. Second, it allows owners to accurately estimate what their future expenses will be and how much income they’ll need when they exit. The clear division highlights the expenses that the business covers today and that the owner will have to cover in the future, such as salary and benefits, health and life insurance, entertainment, and more. Owners who fear they can't cover these expenses may never be able to leave the business or retire.

3. Understand the value of the business

Nearly two-thirds of business owners say they’ve had their business valued in the last three years. (Source: 2018 MassMutual Business Owner Perspectives Study). However, it’s not uncommon for business owners to value their businesses themselves, have a stale valuation, or simply rely on formulas. Merely guessing or making assumptions about value tends to result in an overinflated, unrealistic figure.

“The business is often the largest asset in an owner’s estate, but they don’t know its value,” said Vanderzyden. She admits that valuation is complicated, which is why she advises clients to engage a specialist during the exit planning process. (Related: Know the value of your business)

Once owners understand the key value drivers of their business, they can focus on those, making necessary adjustments that can help grow the business, make it more transferrable, and help them exit on their terms.

4. Identify and prepare the right successor

A sad reality is that some successors aren’t aware they are the chosen ones. This means they haven’t been groomed to take over and may not even want the job. Building a strong management team before you exit can add value to the business and help ease the ownership transition. Whether your plan is to sell the business or pass it on to the next generation, having experienced, knowledgeable and passionate leadership can help ensure that the business continues to be successful when you are no longer there to run it. (Related: Succession planning)

5. Determine your second act

Business owners have to be emotionally ready to leave, which requires designing a post-ownership life. Will it involve traveling the world? Spending quality time with family? Volunteering or mentoring? Or starting a new venture? Each owner will have a different view of the future. There’s no right or wrong way to live a happy and fulfilling life in retirement. The choices are unlimited and deeply personal, which makes the design process challenging, particularly for an individual whose business has been the center of their universe.

Many owners aren’t aware of how important exit planning is to their future and the future of their business, so it’s no wonder remorse sets in so quickly. To avoid this pitfall, set your sights on being knowledgeable and well-prepared. You spent years building this business, give yourself ample time to prepare for your exit and reap the rewards of a lifetime of hard work.

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A successful exit plan starts early. Your MassMutual Financial Professional can help you plan and prepare yourself and your business for an exit – whenever it may be.

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1Source: State of Owner Readiness Survey, 2018, Exit Planning Institute

The information provided is not written or intended as specific tax or legal advice. MassMutual, its employees and representatives are not authorized to give tax or legal advice. You are encouraged to seek advice from your own tax or legal counsel. Opinions expressed by those interviewed are their own and do not necessarily represent the views of Massachusetts Mutual Life Insurance Company.