Before starting your business, prepare an exit strategy

One of the biggest mistakes entrepreneurs make when starting a business is that they never stop to think about how they will turn out when the time is right. Everyone dreams of that IPO, but the truth is that hardly anyone sees that day. So why not take a couple of hours to sit down with yourself, your attorney, or your business partners and devise the right exit strategy when it’s time to quit.

There may be several different reasons for doing it. Many different “triggers” can set the stage for an owner’s departure. If there are multiple business partners, there will be a time when someone will seek to disconnect the relationship. In addition to death or retirement, such trigger events could also be the firing of a key employee with paid stock as incentive, or a divorce or bankruptcy of an owner. The last thing a company wants is a bankruptcy administrator who tells them that he is now a partner and will seek to liquidate his position, or a divorce attorney who tells the other members that they will soon be partners with an ex-spouse. In other words, something will happen along the long journey of owning a business, and generally that something is not a good thing.

This article is not about providing cross-purchase tax advice for a reinforced tax base, nor is it about IRS compliance with an alternative minimum tax imposed on the corporation because it was paid with life insurance proceeds after one’s death. of the owners. It would be too long and difficult for the average reader. More importantly, those conversations are best left to CPAs and business attorneys to discuss with their clients.

If you can get something out of this article, think about your exit strategy before going into business. The simple rule is that if you don’t, you will find that: one, the business does not have the retained earnings to pay one of the business owners and he or she wants to exit almost immediately; or two, you didn’t set up the purchase correctly and now there are major tax implications. So, here are some things to think about:

One, do all the owners of the business own the same percentage? If that’s the case, then it’s easy. Talk to your accountant or attorney and determine how you should pay for life insurance to get the best tax benefits for the business, as well as to care for the deceased owner’s heirs. If not everyone has the same percentage, then you will have to find a way to care for the whales and at the same time not fully burden the minnows. Buying a whale could completely destroy a business, while the same transaction could be as easy as paying a check for a minnow. So you may need to know how to buy from the bigger investors.

Second, if you are selling your business to an employee or a third-party buyer, perhaps there is an easier way to make the deal than simply looking for immediate cash. If the business is profitable, few people will have the ability to buy a business at such a high price. Then there is the topic of capital gains to think about. Here’s an idea: if you’re going to sell yourself, why not get paid over time? The owner could withhold a lesser amount of his salary and retain his voting rights, which would also provide them with insurance and other benefits that he has become dependent on over the years. Most owners do not trust this because they fear that the business will fail before they are paid in full. However, if he or she is still going to have a say in the business, this greatly decreases the chance of this happening. There could also be majority control until a certain amount of the purchase is completed and then a waiver of control begins within the company. The point is, if there is a plan worked out like this ahead of time, someone could start down this path earlier and still be in the same position they wanted rather than trying to find a buyer with enough cash to buy the business outright.

Third, determine whether your shares, especially in a closed corporation, are really negotiable to an outside buyer. The real answer is that they probably aren’t. It is very difficult to find a buyer for a company and even more difficult to sell shares in a closed corporation on the open market. If a potential buyer has the cash to do so, they will most likely go out and start a business on their own. It is very difficult on a personal level to buy an established company that has other owners. It takes all the right personalities to make it work. For most, it is like eating from someone else’s plate. It is not attractive to most entrepreneurs. There are too many potential problems. An entrepreneur with cash will want to start a business and run it his own way. Therefore, be honest with yourself when determining whether there really is a market for your stocks.

Fourth, decide how you are going to value your business or your shares in the company. Will it be the direct book value or some other type of method to determine the value of the company? There are many different ways to determine the value of a business, depending on whether it has many assets or whether it provides intellectual property or services, etc. Business owners must decide which one they want to use and then make an effort every two years to review the formula and vote to decide whether it is still a relevant or feasible way to assess the value of the business.

Fifth, business owners must determine whether they will have a preemptive right. Will the outgoing owner be able to sell his shares on the open market? Will the company buy the shares and hold them as treasury shares? If the owners are to have a right of first refusal, it is again important to know the value of the shares. In addition, this right of the other owners must be exercised in a reasonable manner. They cannot unduly prolong the event. Since personalities are so important in a business, owners left behind will generally want to have a say in the matter. On the other hand, there also needs to be notification guidelines for an outgoing owner. Many companies impose strict penalties on any owner who gives less than six months’ notice, so there will be time to find a replacement.

Finally, it is imperative that there is no confrontation with one of the owners. What happens here is that a homeowner who walks out draws a line in the proverbial sand and tells others to buy it in full at a certain point. If this does not happen, there will be an asset sale or an attempt to sell the company entirely. You may think that there is no way for this to happen without the other owners agreeing, but if you are a super-majority owner, then the others should start looking for a new job.