Planning for the end game – your business exit strategy.

According to Associate Professor Chris Graves “Family businesses in Australia play an important role in our society, and our economy. They represent 67 percent of all Australian businesses, provide 55 percent of private sector employment, 48 percent of total private sector wages paid, and half of all gross industry value added in Australia.” [1] This value to Australia's economy is why we want to see small businesses continue to succeed, grow, and thrive well into future generations even if it's time for the current owner to depart.

Every business owner will leave their business at some point. How easy this will be and how much financial benefit you or your heirs will achieve will depend largely on how well you have planned for this transition.

Recent research by KPMG has led to KPMG Enterprise Associate Director Richard Cooper concluding “The biggest hurdle a family needs to overcome is recognition that there needs to be a plan. A plan that considers the views and core needs of individual family members, whether they are active in the business or not, that sets clear expectations on family members, and which is in the best interests of the family and the business.”

If you haven’t started thinking about when and how you are going to leave your business, it’s a good idea to start now. The aim being to extract as much value for you and your family as possible, for all the time and hard work you’ve put into your business.

This article covers:

1. Things to consider in your business exit plan.
2. How to estimate what your business is worth.
3. The three main ways to exit your business:

• • Closing your business down,
  • Selling your business, or
  • Succession planning to pass it on to family members, business partners or management.

1. Things to consider in your business exit plan.

There is a lot involved in planning your exit from your business and it is not just about deciding what to do with the business. Many people are affected including your family now and the next generation, business partners, employees, customers, suppliers and professional services providers. To create a comprehensive and advantageous plan you’re likely to also need the services of lawyers, accountants, valuers, and business brokers. With so many stakeholders involved it’s important to start planning early. It is also recommended to include family members and business partners in the planning stage as it’s important to consider their views and objectives too.

Another reason to start planning early, is it may change the way you manage the business. Building a business to sell requires different management decisions compared to building a business that you intend to simply close when it comes time for you to leave.

As a starting point, here are some questions to get you thinking about some of the things you’ll need to address. The list is not exhaustive but should help to get you started.

Firstly, think about what you and your family want.

• What are your personal goals and objectives?
• What are your financial goals?
• When do you want to get out of your business?
• Have you discussed your goals and objectives with your family?
• What are your family’s goals and objectives?

Then consider the future of the business.

• Is there a viable future for the business?
• Do you have a preferred exit option: pass on, sell, or liquidate?
• Have you discussed your goals and objectives with your business partners?
• Have you documented what may happen and what you will do?

The next question then, is how much the business is worth and how you extract that value.

• Do you know the market value of your business?
• Do you know what drives that value?
• Is that value, i.e. your business, attractive to others?
• Do you have the right business structure to limit liability and be tax effective?

Finally, there are the legal and financial considerations.

• Have you spoken to a financial planner about your wealth aspirations?
• Have you talked to your accountant about tax related matters?
• Have your documents (Will, Buy-Sell agreements etc) been drawn up by a lawyer?
• Has your lawyer explained all the legal ramifications?
• Have you talked to your bank manager about your succession plan and any finance considerations?

2. How to estimate what your business is worth.

One of the big questions for business owners when considering their end game is “What is my business worth?” Answering this question is always hard as there are several valuation techniques and it depends on the economy, the industry you’re in, prevailing market conditions, and if there are potential buyers in the market when you’re looking to sell.

The true value of anything is what someone will pay for it. However, if you want to estimate how much your business is worth before you sell it, then do some thorough research on the market or get someone who is experienced in valuing businesses or the assets you wish to sell. This may be a qualified valuer, your accountant, a business broker, auction houses or real estate agents. While getting a valuation will cost you money, it can provide you useful information to help with decision-making and negotiating the sale of your business or its assets.

There are two basic forms of business valuations:

1. Asset-based

2. Earnings-based.

Asset-based valuations

Asset-based valuations generally do not take into account any goodwill or ‘going concern’ value for your business. That is, they’re purely based on the value of the business assets. These valuations are most suited if you are:

• closing your business down,
• assessing how much insurance you need,
• deciding on security for finance, or
• working out how much it would cost to set up a new business from scratch.

To make things even more interesting, there are a number of different asset values that asset-based valuations may provide.

(i) Book Value - the depreciated value stated in your financial statements.

(ii) Market Value - the current market if the asset is sold after adequate marketing and time.

(iii) Liquidation Value - the current value if the asset is sold with minimal or no marketing.

(iv) Replacement Value - the price to buy the assets new.

Earnings-based Valuations.

If you wish to determine the value of your business as a ‘going concern’, including goodwill, then the valuation is based on earnings, that is, how much cash flow or profit the business may generate in the future.

This type of valuation values the assets and goodwill based on future profitability.

There are two main methodologies.

(i) Earnings multiple/capitalisation of earnings. This method projects what profit the business can potentially earn in the future and converts that into the rate of return a purchaser might achieve on their investment.

(ii) Discounted cash flow. Using this method, the business projects its future cash inflows and outflows for 5 to 40 years and then uses an investment/interest rate to calculate what they would be worth today.

Both methods require you to make assumptions about the future earning capacity of the business and its assets, meaning they are open to a lot of interpretation and different results.

Remember, while valuations can give you a guide to the potential value, it is the purchaser who ultimately determines what the value is to them. If the purchaser sees the business adding more value to their current position, they may pay a higher price than a valuation estimates.

It’s a good idea to do some research and gain an understanding of how businesses are valued in your industry and what drives that value. This may help you make decisions that could potentially increase the value when it’s time to exit your business.

3. The three main ways to exit your business.

When planning for the end game it is important to have an idea of whether you intend to close it, sell it, or pass it on. Because your exit strategy will have an impact on how you run your business on a day-by-day basis and what business plans you need to put into place.

If you’re thinking about closing it down, you will probably not be concerned about what the business looks like on the final day. Most likely there would be little stock, or inventory, left, your equipment may be on its last legs, and you may be at the end of any long-term contracts such as the lease of your premises. You would also probably be saving your profits in your superannuation, or other investments, to prepare for life after this business.

Conversely, if you’re thinking of passing it on to staff or management, your day-to-day activity would be about ensuring the business is well maintained, fully stocked, and has serviceable equipment. You may also be training your potential successor and considering how to facilitate the buyout and finalise the transfer of ownership .

If you’re thinking of selling your business, day-to-day activities would be about investing time and energy in making sure the business looks attractive to a potential buyer, showing good efficiencies and profits, documented policies and procedures and sustainable future sales prospects.

When you're considering the best exit strategy for you, remember, if you are thinking about closing your business down, it’s almost like saying that all that time, effort, and money you put into building up a successful profitable business, was worth nothing. That it's only worth the stock and assets that remain. However, if your business is truly profitable, it has what is called goodwill. But to realise the goodwill, you have to plan to sell or pass your business on.

For more in-depth information on the 3 ways to exit your business, close it down, sell it, or pass it on please see the other articles on the Davidson Institute website.

[1] Based on economic modelling undertaken by Associate Professor Chris Graves, The University of Adelaide, using Australian Bureau of Statistics data and IBISWorld data on the largest 2,000 unlisted Australian businesses.

This information is general in nature and has been prepared without taking your objectives, needs and overall financial situation into account. For this reason, you should consider the appropriateness for the information to your own circumstances and, if necessary, seek appropriate professional advice. © Westpac Banking Corporation ABN 33 007 457 141 AFSL and Australian credit licence 233714.