Most owners wait too long or fail to create a plan for exiting their business. There’s a common misconception that leaving or selling your company is a one-time event, the last stage of a business’ life. But if you want to get out what you’ve put into your company for the last 10, 20, or 30 years, you have to treat your exit like a multi-phase period, and you have to give it the time it needs, not treat it as like a single event that happens to you. Often, business owners are put in a position to sell it sooner than they expected, leaving them unprepared to exit and their businesses undervalued.
How much time is enough to build and implement an exit plan?
The right date to start working toward your exit strategy is the day you start your business. But since you’re probably a few years past that, let’s figure out yours by reverse-engineering it. As you are about to discover, you should expect the process to take at least five years from the time you start planning.
The Five-Year Exit Strategy
- Year Five: You’re Out!
From the day the business is sold, you need about a year to make your actual exit. You’ll work with a business broker and an investment banker to get through this final period.
Before that year, plan on at least three years of getting your financials in shape.
- Years Two Through Four: Financial History
To get the maximum value before the sale, you’ll have to show your last three years of financial history, at minimum. Any buyer, even if you’re selling to a family member, will want to see at least that. If you don’t have that history or you’re not satisfied with your numbers, you’ll have to spend at least three years building them up.
Say, for example, you want to get the business to a net profit of $500,000 per year and sell at four times that. Then, say in year three, it gets to $500,000 in net profit and is assessed at four times that. You want to get the numbers for three consecutive years. Once you see $500,000 on the bottom line for three years, that’s when you go to market and sell.
- Year One: Setting the Foundation
You will probably need a year prior to those three years to get the foundation right. This is the time to look at stabilizing the business, optimizing profitability, and getting the processes in place.
So, at the bare minimum, that gets us to five years of planning and preparation, so nothing is left on the table. However, many buyers want at least five years of financial history, not three, which could take our timeline to seven years. Then, it might take two years, not one, to get the fundamentals right, so the most realistic timeline may be more like five to ten years.
Analyze, Optimize, Strategize
Like any journey, a smart business exit begins by figuring out where you are, where you want to go, and how you’re going to get there. There are three basic phases to work through.
In Phase 1, do an assessment of the business and see what’s working and what isn’t. Decide your goals for the future of the company.
In Phase 2, look at optimizing the financial business model. Focus on profit improvement, making sure your margins are higher than your competitors and that you have a good, profitable enterprise.
In Phase 3, take an honest look at the management structure, starting at the top – that’s you. How involved are you in the business, and what key roles does the leadership play? If all the power is concentrated in a single person, you must look at making it more of a team that can continue functioning seamlessly after the all-powerful owner (that’s you) is gone.
Once the numbers have stabilized, it’s time to look at growth. How can you grow at the newly optimized level? This is also the time to plan the exit itself: deciding whether to sell to a third party, internal employee, family member, or other entity. Decide how you will execute the strategy and who needs to help you get to the finish line.
All these things are equally important, and they build off each other; you can’t do them out of order, and this is no time to multitask. For instance, if you try to grow the business before you optimize your margins, you’re growing your business at a lower margin,n and the results will be less than they could be.
Profit Matters
It really comes down to profit margins, which come down to expenses. While many business owners think their operations are lean, I have found that several of them are overspending on their overhead or operating costs like marketing, staffing and rent. I find that when compared to other businesses in their industry, 90 percent of the time, their profit margins are much lower than the average.
The businesses I see have not increased their prices at the same rate of inflation that’s hitting their costs; most of them will increase prices five percent while inflation was closer to 10 percent. Many of them don’t realize the impact inflation has had on the business. If you don’t have a good system in place to give you a solid financial picture, you’re going to get caught up in the vanity of revenue – and revenue doesn’t matter in business valuation. What matters is profit. You can have piles of revenue, but if you have mountains of expenses, your profitability will only disappoint.
One of my clients didn’t raise her fees to cover her skyrocketing transportation costs for employees working offsite in her customers’ offices. She didn’t realize the impact that was having on her overhead. Her net margin was going down year by year, so we came up with a different pricing structure for off-site business owners that would cover the expense.
Those profit margins are very important in the sale. If someone looks at your numbers and sees that you’re not really charging the true cost of business, that’s going to lower the value of the business. A new owner doesn’t want to have to come in and implement the change that would fix that.
Take Your Time
Of all the mistakes business owners make in engineering their departure, a significant one is simply not devoting enough time to it. They let real-time activities dominate their days, neglecting the important matters that are essential to long-term success. Make a point to carve out enough time for things like exit strategy and planning.
A successful exit depends as much on the time you devote to it as the financial and management details you work out. Create a time block of one to two hours a week to work on your long-term exit strategy.
You have a 10-year horizon for this entire process to come together. Use it – starting now.
This article was originally published by Mentors Collective Success Magazine