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Do I Need an Exit Plan if My Employees Will Buy My Business?

Business Owners’ Special Series #19 09.08.20

Man smilingWe often hear stories from business owners who had great ideas about how they wanted to exit their business and how they prepared a do-it-yourself exit plan. And while they were confident they had thought of everything, there were often overlooked details that undermined their best laid plans.

To best answer the question “Do I need an exit plan, if my employees will buy my business?,” here is a common scenario to illustrate:

Jeff had thoroughly prepared to transition ownership of his project management company to two key employees, Mary and Mark. Mary and Mark had been key employees for over 15 years, their technical skills were excellent and they had strong professional relationships with clients, so client retention was strong. Additionally, the business had well documented processes and procedures in place.

Jeff discussed his transition of ownership to Mary and Mark for well over five years prior to execution date, and planned accordingly. His plan detailed how Mary and Mark would buy his shares over a five-year period, after Jeff’s 70th birthday. The only weakness Jeff could see in his plan was Mary and Mark lacked a strong understanding of the financial statements and related financial matters, but Jeff had five years to help them learn.

Over the next five years, Jeff hosted monthly financial meetings with the two future owners where they reviewed the profit and loss statement, the balance sheet, the aging accounts receivable, and current year budget versus actual results. He also reviewed reports that were unique to the business, which Jeff thought were critical for Mary and Mark to understand. After two years, Mary was running the monthly financial meetings, Mark was an active participant in these discussions, and Jeff was quite pleased.

When Jeff turned 70 and was ready to sell his business to Mary and Mark, everyone was well-informed and prepared. The legal documents were drawn up and ready for signatures.

But everything came to an abrupt halt when Mary and Mark prepared to sign two specific documents. The first document that threw up red flags for Mary and Mark was the personal guarantee by owners required for the bank line of credit. The second document was the owners’ personal guarantee required on the lease. Unfortunately, during all the preparation for an exit, Jeff made two critical mistakes in his planning.

The first mistake was not assessing his employees’ appetite for entrepreneurial risks of ownership. Mary and Mark had been adequately prepared to run the business without the founder and ready to accept the rewards of owning this business. They were not, however, prepared to accept the risk of ownership. The second mistake was not having an alternative exit plan.

Jeff did not properly assess his key employees’ attitudes about entrepreneurial risks. At the time of this transaction, in addition to owning his business, Jeff had a significant investment portfolio, substantial retirement savings, two homes with no mortgage, and was financially well-off and debt free. The owner-guarantees on the line of credit and the lease was not significant risks to Jeff. His key employees had no assets other than their homes, which had significant mortgages, they each had children in expensive private schools, and they saw incredible college tuition costs looming in the near future.

In view of their fragile finances, Mary and Mark found the owner guarantees to be terrifying. Jeff never prepared Mary and Mark for the personal guarantees and the risks associated with owning a business. While these were not significant risks to Jeff, he never saw the risks through the eyes of his potential buyers.

Jeff had no intention of working past his current age of 70, and now he suddenly had to take his business to market, which he was not prepared to do. At the end of the day, Jeff sold his business to a large competitor for a discounted price. Mary and Mark worked for the buyer, and they never became business owners.

In this situation, effective exit planning would have done at least three things to change the outcome for Jeff:

  1. In addition to pursuing the preferred extra strategy, which Jeff did, also prepare the business for alternative exit plans, which Jeff did not do.
  2. Giving Jeff the tools to see his business through the eyes of the buyer. Jeff’s failure to do this is a common one that kills deals or lead to outcomes that are detrimental to an owner’s exit plan and retirement goals.
  3. Fully assess Mary and Mark’s beliefs and attitudes toward owner responsibilities early in the process, and show Jeff that selling to his key employees may not be a viable strategy. In this situation, alternative plans would have been made and Jeff would have had a far more successful outcome with no surprises.

If you want to maximize the outcome at your exit, eliminate surprises, fulfill your retirement goals and have a successful post-exit life, then you should always have an effective exit plan. There is no such thing as beginning your exit planning too soon, as an early start yields far better results. If you spent half your life building a business with your heart and soul, do not sell yourself short with a DIY exit plan. Start early, assess several alternative exit strategies and engage exit planning professionals to develop an effective exit plan. This will help you stay focused on the exit planning process for a successful outcome.

Contact Us:

Rich Gunn leads BPM’s Value Acceleration Service Team, which helps with succession, transition and exit planning for business owners. Rich is a Certified Exit Planning Advisor and a member of the Exit Planning Institute.

The Business Owners’ Special Series (B.O.S.S.):

The Business Owners’ Special Series (B.O.S.S.) is a library of information for business owners who are proactively seeking guidance from experts on how to implement value acceleration in their business. Be sure to keep reading, if you desire to develop your business to its maximum potential value and gain an understanding of how and why beginning the process sooner results in building greater value.